On August 5, stocks in the United States continued on a downward trend, with most major indexes down 1%. After setting record highs, the Dow Jones and the S&P 500 have lost all the gains they had made thus far in 2014. Corporate earnings have been a mixed bag, with some heavy losses in the energy and utilities sectors, both of which stand to be hurt by turmoil in Ukraine.
Although some of the current global crises can account for some of the sustained market losses, it is clear that the more direct concern for investors and firms is how the end of direct monetary stimulus (in the form of bond and asset-backed securities purchases) will change the financial landscape.
It has been reported that an unfortunate side effect of flooding the financial system with liquidity is that prices for so many things have become quite high. Bloomberg just published a piece about the $50 Billion in cash reserves that Berkshire Hathaway is currently sitting on. The investment group, run by the iconic Warren Buffett, has been lauded for making investments based on market fundamentals especially in the wake of the 2008 financial crisis during which many institutions appeared to have ignored market realities in the pursuit of getting big bonuses and surpassing quarterly earnings expectations. As a result he and his employees have watched money pile up, as the high prices for stakes in new emerging industries such as social media and biotech, decrease the likelihood of Buffet's investors getting the stable return they have become accustomed to.
As a result of loose monetary policy and low interest rates, investors have had to rely on increasingly risky investments in order to get a return of 4%. This explains why Berkshire Hathaway feels like it is smarter to hold on to the money than to spend it on overvalued assets, why social media brands like Facebook and Twitter, continue to be illogically overvalued, and why a nation as financially troubled as Greece is able to sell 10 year treasury notes at a 6% interest rate.
In this context we must not view this market dip as a negative event, but rather a desperately needed adjustment that will begin to return equities to a more reasonable price range based on market forces. The Federal Reserve will try to make the landing soft, but if the last financial panic taught us anything, it's that prices can not go up forever. Prices can only go as high as demand, income, and utility will allow, and corrections like these are better in the long-term than the alternative, which is wild growth followed by devastating collapse.