The Dow dives another 350

6 thoughts on “The Dow dives another 350”

1. Thanks for your informative posts, Adam Tondowsky. Boy, do I remember Bush the Elder’s obsession with reducing capital gains taxes. Remind me why income from long term stock investment deserves to be taxed at a lower rate than income from labor, or from interest on bank accounts and bonds? To help people retire? Or because rich people won’t own stocks otherwise?

2. In regards to my previous post on economic analysis, there is a much more sophisticated tool called econometrics which attempts to isolate the effects of individual factors. However, econometrics is to even most economists as quantum physics is to even most physicists. So, econometrics is way above my abilities.

   In the long run I support eliminating corporate taxes and increasing capital gains and dividend taxes to the ‘normal’ rate. In that way, any corporate profits that are reinvested in the business aren’t taxed, but those that are paid out are.

   Capital gains taxes weren’t at the normal rate, but starting in the late 1980s or so, there was an enormous propaganda campaign about the need to cut capital gains taxes in order to allegedly increase investment. When the Republicans took Congress in 1994, it was one of the first things they started working on and capital gains taxes were further cut in 1995 or 1996.

   I don’t think it’s a coincidence that since then there were the bursting of asset bubbles in 2000 and 2008, whereas there hadn’t been a U.S domestic asset bubble burst prior to these since the stock market crash of 1929.

3. (One aside on Keynesian economics: Keynes himself argued that fiscal policies to stimulate the economy during a recession needed to be offset with fiscal surpluses during times of ‘normal economic growth. So, in effect, Keynes himself is not a Keynesian.)

   3.I’ve written before that ‘an inverted yield curve’ is generally regarded as being bad for the economy, but a ’tilt in the yield curve’ is generally regarded as being good for the economy. A ’tilt in the yield curve’ obviously is where the Federal Reserve rate increases at the same time as 5/10 (whatever else) year rates decline. A tilt in the yield curve suggests that bond traders believe that the Federal Reserve is successfully dealing with inflationary pressures. Outside of psychological sentiment, it also means that the rate that most people and businesses borrow at has declined, which is directly good for the economy.

   Of course, economic analysis is based on the principle of ‘all else being equal’ which is usually not how the world works. In this case, the Federal Reserve raised rates at the same time as oil prices have dropped sharply, so it’s hard to know which of these has had the bigger effect of causing longer term interest rates to drop (there are probably other factors as well.)

   However, the decline in long term rates should be good for the economy going forward, if they don’t rise again.

   Another consideration though is that the rise in interest rates has caused the U.S $ to increase which makes both exports less competitive and imports more competitive.

4. 1.According to the Wall Street Journal, the P/E ratio (Price to Earnings) of the DJIA is still around 19, however the one year forward future expectations are 15 (based on present price.) A way to look at that is to ‘one over’ the P/E, so 1/19, which is slightly over 5% (0.05.) Normal expectations of stock market returns or P/E is around 7%, so the future expectations of 15 is right in line with that.

   2.The corporate tax cuts since they directly increase corporate (after tax profits) undoubtedly had an effect on raising the DJIA (and other stock markets) but their overall effects are more complicated. I don’t believe it was Milton Friedman but another Monetarist who made the famous saying (among economists anyway) “in the long run, the fiscal multiplier is dead.” This is an obvious direct rejoinder of Keynesian economics which argued that fiscal stimulus could be effective during all stages of the business cycle, rather than just during recessions.

   The relatively immediate impact of the short term fiscal stimulus therefore caused by the tax cuts was not a surprise: an increase in inflation and an increase in longer term interest rates.

   So, essentially, the corporate tax cuts provided a benefit to profitable companies, but raised future borrowing costs on those who get loans at longer term rates (mortgages and many businesses) which obviously depresses economic activity.

5. I can be accused of being overly sanguine, but I wouldn’t worry about this all that much.

   1.The DJIA mostly represents the opinions of a relative handful of billionaires and mutual fund portfolio managers. The idea that it represents the economy is, in my opinion, a myth.

   2.This is something of a speculative bubble declining if not collapsing, since the DJIA didn’t have any reason to go from approximately 19,000 on election day in 2016 all the way up to the peak of around 26,500. Economic fundamentals and future expectations don’t explain such a large increase.

   3.With the uncertainty in the economy, I suspect the deciding factor the Fed raised their rate another 25 basis points is that Trump told them not to and the Fed wanted to assert its independence. However, the guidance from the Fed reflects the uncertainty. So, I think the economy can survive a 25 basis point hike. The Fed rate at 2.5% is now only slightly above inflation, so it still hasn’t been fully ‘normalized.’ For a greater discussion on that, google ‘Taylor Rule.’

6. IMO, this is worse than it seems, because it is not a speculative bubble collapsing like in 1929, it is potentially the economy collapsing, like in 1931. Of course, there are many things in-between that, and it could just reflect the fact that with Trump in power, the future does not look very bright.

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