Stock markets have become increasingly bearish since the election.
With the fiscal cliff approaching, and little confidence that Democrats and Republicans will agree on a solution to avoid it, the Nasdaq Composite Index, which includes many technology stocks, and the small-stock Russell 2000 Index are now in correction territory.
A bear market takes place when the market drops 20% or more. A correction takes place when the market drops 10% or more. Both indexes are down more than 10% since reaching highs in mid-September.
As The Federal Reserve Board’s quantitative easing drove investors to put money in riskier assets, both indexes soared earlier this year. Since the third round of quantitative easing (QE3) began, though, both indexes have been heading down.
While Republicans agreed immediately after the election to accept some increase in taxes, President Obama has said that he will seek $1.6 trillion in tax increases, which is twice what he previously suggested and is far off what Republicans are willing to accept.
In addition to being driven down by the fiscal cliff, markets are being depressed by continuing turmoil in Europe, and the economic slowdown and change in leadership in China.
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Until recently, markets were heading up, driven higher by quantitative easing programs in Europe, as well as the U.S.
Noting that quantitative easing was no longer having a positive impact on the markets and that, in fact, the market spikes it caused were starting to ebb, we shared the following chart with clients in our monthly letter.
The “Draghi Spike” refers to European Central Bank (ECB) President Mario Draghi. The “FOMC Spike” refers to the U.S. Federal Open Market Committee, led by Fed Chairman Ben Bernanke.
The S&P 500 is now within striking distance of the low end of the Draghi spike, at which point any gains from the latest rounds of quantitative easing will have been erased.
This outcome is no surprise. As with government stimulus spending, the positive impact of quantitative easing is temporary. In addition, each successive round becomes less effective than the previous round.
It wouldn’t matter if quantitative easing had no other impact, except to boost the stock market, but that’s not the case. It also encourages risky investment and can cause new problems, such as inflation.
And it really does nothing to heal a sick economy. It’s like drinking alcohol to relieve stress. It hides the problem, rather than addressing it.
The latest quantitative easing program was supposed to help ease unemployment. That seems not to have happened.
Neither stimulus spending nor quantitative easing have had much of an impact on the economy. So what do we do now?