According to Bloomberg, there’s a 53% chance that we’ll drop into a recession in 2020.
The stock market saw massive drops last Monday and Thursday, enough to trigger automatic safety mechanisms that temporarily shut down the stock market. That’s a big deal: according to the Wall Street Journal, these automatic safety mechanisms haven’t been triggered since 1997. Another massive drop happened just yesterday, with the Dow Jones Industrial Average (which tracks the performance of 30 of the most solid, well-known companies in the U.S) dropping 12.9% after the stock markets closed.
So what’s causing the drop? Are we going to go into another recession? What does this mean for the everyday investor? Finally, my economics degree has a chance to shine. Here are the four main factors that I think are responsible for the current crazy market.
1) Coronavirus
Because of coronavirus, people are going out less, businesses are struggling, and companies can’t make payroll. People in blue-collar and service jobs are losing their jobs, and elderly people are dying. There’s no question about it: this virus is going to have huge impact on the economy and the housing market. Markets dropped because the current outlook for the future is not good.
If you’re interested, I wrote an article on how coronavirus’ was able to spread so explosively and the mismanagement that went on behind the scenes in China.
2) Speculators
A lot of the volatility we’re seeing in stocks right now is due to speculators. Speculators are people who buy and sell stocks based on the noise in the market. For example, buying a stock based on “gut feeling” or “because a friend told me to” would be examples of speculation.
In economic theory, it is believed that the market is composed entirely of:
- investors (who always make rational decisions), and
- speculators (who sometimes make irrational decisions)
Even though the market will eventually bounce back, as it always does, it’s hard to watch it drop. People see that they’re losing money, so they’d rather sell out and wait with cash for the market to recover. The panic causes a chain reaction where the market drops -> people sell out -> the market drops even lower -> and the cycle repeats. This mob mentality can drive the market up or down more than it rationally should.
In short, speculation is powerful and can make the markets behave irrationally.
3) The Federal Reserve Scare
When the US government saw what coronavirus scares were doing to the country’s economic stability, it took two major actions:
- It cut the federal funds benchmark to 0%. When you hear on the news that “the Federal Reserve cut interest rates to 0%”, that means they cut the target rate for the federal funds interest rate.
- The federal funds target rate, which is now 0%-0.25%, is the interest rate at which banks borrow from each other.
- This is not to be confused with the discount rate, which is the rate at which banks can borrow from the Federal Reserve.
Since you wouldn’t borrow from the Federal Reserve unless no other bank would lend to you, the discount rate is normally higher than the federal funds rate.
- It purchased $700 billion in open market operations.
- When the Federal Reserve buys or sells large amounts of government bonds, this is called open market operations.
- When the Fed buys government bonds in the market, this injects more money into the economy.
- It also forces new bonds to be issued at current lower rates, which helps push interest rates back down.
Combined, these two actions are called quantitative easing. This method is used to help lower interest rates and push the economy out of a recession.
But when these changes were announced, the market dropped even more. In fact, it dropped so low it triggered a circuit breaker and trading halted.
The Federal Reserve used almost every weapon in its arsenal to keep the current market under control. Now that the federal funds rate has dropped to 0%, the Federal Reserve doesn’t have much left it can do if the market continues to drop.
4) Saudi-Arabia Russia Oil Wars
With everyone in self-quarantine, not many people need oil. No one is really driving their cars anywhere. Businesses aren’t transporting anything. And airplanes aren’t flying. As a result, there’s been a drop in the demand for gas. With that drop in demand comes a drop in price.
Russia and Saudi Arabia, along with other big oil-producing countries, held a meeting in Vienna to discuss how to keep oil prices from falling too low. Saudia Arabia proposed decreasing the supply of oil, but Moscow refused. Instead, Russia slashed prices AND massively increased oil outputs, which drastically brought down the price per barrel of oil. Foreign Policy did a great job of covering that story.
Countries like Saudi Arabia and Russia, which largely rely on oil for their livelihood, are going to suffer major losses until a winner emerges and they reach an agreement. As a result, markets dropped since oil producing countries, and the countries that trade with them, are all going to be negatively impacted.
With all of these factors, we’re on track to drop into a 2008-level recession (or worse). And while it might be scary to be investing in the market right now, there’s actually no better time than now to invest. For a long-term investor like me, the current market is a 50% off sale with some great bargain deals. If you have money to spare, now is a great time to start investing. Just remember that:
- You should save a cash fund of 3-6 months of emergency expenses before you start thinking of funneling money into stocks. Put another way, don’t invest money that you might need in the next 6 months.
- Don’t panic sell. When the economy recovers, as it always will, you’ll regret selling when the market was so low.
- If something sounds too good to be true, it probably is. Make sure to invest only in companies that you have faith will live through this recession, not on penny stocks or companies you’ve never heard of.