Illustration: Marianna Pantelli
While 2017 marked a profitable year for a booming stock market which saw the DOW break record earnings, a sudden and severe drop in early February quickly erased the existing 2018 earnings. Reportedly, what makes this drop so notable is that it has been dubbed “the greatest single-day point drop in history during a trading day,” losing almost 1,175 points in one day. Although the drop in percentage of the market was only 4.6 per cent, which could scarcely be compared with the havoc of the 2008 financial crisis, it is indeed the biggest decline since the European debt crisis of 2011.
Although after the second major dip on 8 February the market does appear to have begun settling, the reason for the initial drop is worth exploring, as similar plunges have occurred during major financial crises.
Much of this drop has been attributed to the change of administration within the United States Federal Reserve, the central banking system with the power to change interest rates on loans. As of 23 January this year, the Senate had confirmed President Trump’s nominee for President of the Federal Reserve, Jerome Powell, instead of Janet Yellen, the former chairwoman.
Trump has broken a decades-old precedent within the Fed of traditionally reappointing the chair of the central bank for at least a second term. The nomination of Powell over Yellen might have come as a surprise. However, the impact of this decision is more than political. The new head of the Fed’s administration is also expected to raise interest rates to curb rising inflation rates. In conjunction with concerns over the President’s controversial high-cost budget, both may have fueled panic on Wall Street, and consequently, the stock drop.
Now, the United States stock market seems to have stabilised once again, but what are the future implications one can take away from this drop?
The volatility of the stock market relies on consumer confidence. It operates on the belief that stocks will increase if the consumers are sure that the stock market will continue to operate successfully.
It is a self-fulfilling prophecy: if consumers continue to invest, they in turn are helping stabilize the market.
On the other hand, uncertainties in the market may spook investors when there are changes in heads of government, bank leaders, or when a company fails.
While it is often said to be the best practice to stay in the market as long as one can – to ride out a storm – the two day dips did raise some concerns over whether this was a result of market uncertainties with interest rates, or of longer-term results of governmental policy changes (which would make a recovery harder).
The volatility of the US stock market sparked fear for investors, whether businesses were dumping stocks they couldn’t afford in fear of hiked interest on loans, or shareholders were buying stocks cheap amidst the frenzy. It was this fear which showed in the immediate short-run measured by the VIX.
The CBOE Volatility Index (VIX) measures the stock market’s volatility as reported by the S&P 500- which is designed to give a wider and more accurate picture of the stock market, compared with the DOW Jones.
As the stock market plunged its record 4.6 per cent earnings on 5 February, the VIX spiked 116 per cent in a single day. While it may be an ineffective predictor of long-term volatility of market prices, the VIX does vividly illustrate the immediate fears of the consumers.
Again, while the market does appear to be settling and bouncing back from previous plunges, it is important to recognize how anomalous these drops are in their severity, especially if they are viewed as a result of the change in administration of the Federal Reserve.
Although every four-year term can potentially bring a change for the administration of the Federal Reserve, fluctuations in the stock market have never been this severe; they post questions about the US stock market’s positive longevity.
How much longer can this positive growth last? It may be too soon to tell.