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OpEdNews Op Eds    H4'ed 2/28/20

Why Are Stocks Crashing?

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"It's that threat of a supply shock an unexpected change in the supply of a product or commodity that is particularly unnerving for investors. They are more used to dealing with the occasional threat of negative demand shocks an unexpected hit to demand for goods and services".

Big, negative supply shocks are rare, Nielsen noted, with the oil shocks of the early and late 1970s offering perhaps the most well-known examples.... The problem is that there's little that looser monetary policy or additional fiscal stimulus can do to offset the impact because those stimulus measures work by boosting demand".

While demand has so far held up outside of China, the disruption to global supply chains running through China, Korea and, potentially, Japan is likely to take a toll on production, wrote Nuveen's Nick. If Asian production stoppages worsen or continue well into the second quarter, a global supply crunch could hit the already weakening manufacturing sector, he said, with implications for jobs and the wider global economy.

Moreover, it comes in an environment where valuations for U.S. stocks and credit markets were "'priced to perfection' or something close to it following the three Fed interest rate cuts last year and the resolution of various trade deals," he said." ("Stocks keep getting slammed because investors fear a 'supply shock' that central bankers can't fix" , Marketwatch)

Until this Monday, investors had been brushing aside the negative news on the coronavirus confident that the Fed would save market as it had done so many times before. Now more people are beginning to see that the so called "Fed Put" will not work this time, that the Fed will not be able to put a floor beneath stock prices because it doesn't have the power to do so. The realization of the Fed's limitations is going to weigh heavily on stocks which had been "priced to perfection" but are presently retracing their steps downward until prices are more consistent with fundamentals and the rapidly-deteriorating economic data.

Here's a quote from an article by Caroline Baum at Marketwatch which helps to underscore the Fed's impotence in dealing with a supply shock:

"The Fed can't produce parts for automobile manufacturers across the globe that are dependent on intermediate-goods imports from China. It can't reopen factories in Hubei Province, the epicenter of the coronavirus outbreak. It can't provide needed factory workers for plants in locked-down areas of China. And it can't create alternate supply chains as a substitute for China's role as manufacturer to the world."

A Fed rate cut is not the prescribed antidote for a negative supply shock. In fact, "the only reason you would cut rates now is if you're the central bank of the S&P 500," said Jim Bianco, president of Bianco Research, using a moniker the Fed abhors." ("Why the Fed can't defend the economy against the coronavirus outbreak", Marketwatch)

There's no doubt that the Fed will cut rates and perhaps even take more extreme measures like monthly purchases of individual stocks and ETFs. But the chance of stocks roaring back into record territory like they did in the heady pre-coronavirus days, are infinitesimally small. The contagion has not even spread to the United States yet, and look at the mayhem it has created. The virus has exposed the essential fragility of a market system that depends on the endless meddling of outside actors whose only objective is to transfer trillions of dollars in wealth to their voracious constituents on Wall Street.

So where is the bottom for stocks that have been grossly inflated for more than 7 years due to extreme monetary easing, below market rates, and regular infusions liquidity?

We don't know, but we suspect there's still a long way to go. As economist Nouriel Roubini said in a recent article in the Financial Times, "Investors are deluding themselves about how severe the coronavirus outbreak will be. Despite this week's big sell-off in equity markets, the worst is yet to come."

NOTE: Thursday's 1,190 point rout was the Dow Jones' biggest one day loss in history. Benchmark 10-year Treasury yields tumbled to an all-time low of 1.26%

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Mike is a freelance writer living in Washington state.

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