On February 3, the Dow Jones Industrial Average had its worst day this year, down 326 points at the closing bell. This continued a recent slump, after hitting a peak at the beginning of the year. Some have connected today’s sell off to negative manufacturing numbers in the U.S. and China, and both numbers are undeniably concerning, but the uncertainty surrounding monetary policy is clearly weighing heavy on the minds of investors since the last ‘taper’ (or reduction in monthly monetary stimulus programs) occurred.
It’s hard to blame anyone for being concerned about what the stock market will look like as the Federal Reserve unwinds unprecedented monetary stimulus programs, because no one can really be sure how the economy as a whole will react. We can estimate with models, but as we have learned throughout the last financial disaster, models sometimes fail to account for human greed and fear.
The Dow Jones surpassed its inflation-adjusted record high in December of 2013, so it is only sensible that people begin to sell as the rate of stimulus slows. Had the market not begun to correct it would have been a pretty glaring omen of a bubble. Thankfully investors do not seem to be as fearlessly bullish as they were during the housing bubble, and they are reacting appropriately to economic circumstance and historical precedent.
As the Federal Reserve begins to move away from monetary stimulus, and eventually from zero-lower bound monetary policy altogether, more people will move more money into bonds, as they are historically safer, and will have greater returns.
It’s hard to be happy when people are losing money, but in the grand macroeconomic scheme having more frequent market corrections like the one that the stock market is currently undergoing are far preferable to the large crash that comes after too many years of delusionally optimistic thinking.