We all know stocks have been selling off. And we all know why. At least, we know what the conventional wisdom says. Stocks are selling off because of slowing growth in China, plunging oil prices, Federal Reserve tightening, and fears of yet another Great Recession. Investors are certainly right to blame all of these factors, yet I think there's something else going on, too. First, let's take a look at each of the above…
Growth in China is definitely slowing. GDP grew at just 6.9% in 2015. Most nations would be thrilled with that level of growth. But for China, this is considered slow. In fact, it was the slowest rate of growth in that nation in a quarter century.
Oil prices have plunged from more than $100 per barrel a year-and-a-half ago to less than $30 per barrel today. This sounds like great news, right? After all, it leaves a lot more money in consumers' pockets. Furthermore, oil and oil-related products are raw materials for all kinds of manufacturers, so their cost of goods is falling. In addition, businesses are saving money on transportation. On the flip side, the U.S. economy has become much more dependent on oil production than it ever was in the past. If oil prices don't go at least a little higher, a number of oil producers might go bankrupt. There have already been a lot of layoffs in the industry.
The Federal Reserve raised the fed funds rate for the first time in years. It was just a quarter point, but it was a move toward tightening. That's got investors worried. Still, interest rates are incredibly low, and any future rate increases will be made at a very moderate pace. And despite the Fed's action, longer-term interest rates have actually moved lower. So money is still very cheap. Even though there is no way one could argue that monetary policy is tight, investors fear the Fed's next move.
Another recession can't be ruled out. So far, however, the evidence suggests that fears of recession anytime soon are overblown. Total employment is still rising. Granted, most new jobs do not pay very well, but it would be extremely unusual to have a recession when employment is rising. The housing market may be showing some signs of slowing, but it is still fairly strong. On the other hand, it is true that the manufacturing sector is contracting, that industrial production is down, and that some companies are reporting that their corporate customers are reducing orders.
So these are definitely good reasons to be concerned. Still, I believe that there are two other factors that have stock investors worried and that are contributing to the recent near-panic levels of selling. These are factors that many analysts are not talking about. At least not yet.
The first is the presidential election. It is becoming increasingly evident that the next president of the United States might be someone who is anything but conventional. You may believe this is a good thing, or you may believe it's not; but one thing is clear. It raises the level of uncertainty. It's still early in the election season, and anything could happen, but right now, on the Republican side, Donald Trump's prospects look pretty good. Whatever you think of Trump, the fact is that he has never been elected to public office. As for the Democrats, Hillary Clinton looks like she's struggling while Bernie Sanders keeps moving up in the polls. He has a lot of political experience, but he's certainly not conventional. In fact, he proudly calls himself a democratic socialist. Socialism and investing? As they might say on Sesame Street, these two things don't go together.
The second factor worrying investors is the federal budget deficit. The deficit peaked at $1.4 trillion in fiscal 2009. By the end of fiscal 2015 it had come all way down to $439 billion, or 2.5% of GDP. That was very good news. The bad news is that the deficit has begun growing again. According to the Congressional Budget Office, the deficit for fiscal 2016 will be $544 billion, or 2.9% of GDP. It gets worse. The CBO says the deficit will increase every year from now through 2026, at which time it will reach almost 5% of GDP.
So in addition to all of the usual risks, investors right now are dealing with a crazy level of political uncertainty in the presidential election and the fiscal shadow of rising deficits.
Of course, none of this makes investing any easier. But it would be a big mistake to sell in the midst of panic. Instead, you should keep a list of undervalued stocks handy and buy when everyone else is selling. After all, if you are investing for the long term, it's always better to buy stocks when they are on sale. And they are much cheaper today than they were at the start of the year. I took advantage of Wednesday's selloff by putting some cash to work in my clients' accounts. I'll be doing more of that if the selloff continues.