Stock market continues to fall

San José, CA – On Monday, December 17, U.S. stocks continued to drop. The widely quoted Dow Jones Industrial Average (DJIA) fell more than 500 points, or 2%. The broader S&P 500 and the tech-heavy NASDAQ also fell more than 2%. All the major stock indices are now down in double digits from their record highs this year, and the Russell 2000, an index of smaller companies, is now in an official ‘bear market,’ as it fell to a level more than 20% below its all-time high. U.S. stocks are deeper in negative territory for the year and have had their worst December since 1931, during the Great Depression.

The stock market decline was very broad, with every major sector in decline. Even so-called ‘defensive’ stocks such as utilities, which benefit from lower interest rates, fell. Oil fell again, along with other commodities, signaling more weakness in the economy to come. Corporate bond prices also fell as investors fear that an economic slowdown will push more heavily indebted corporations to default on their bonds.

The National Association of Home Builders’ Housing Market Index (HMI) fell by four points to 56, the lowest level since mid-2015. This index of home builders’ sentiment has fallen 18 points, or almost 25% since its post-recession high one year ago. The Empire State Manufacturing Survey, a monthly read on manufacturing in the state of New York, fell by more than half to 10.9, the weakest reading since mid-2017.

President Trump ignored the weak economic readings and the economic disruptions caused by his own policies and tried to pin the blame for the stock market fall on the Federal Reserve, the U.S. central bank. While the Federal Reserve has been raising interest rates very gradually, the Federal Funds rate that it controls is only a bit above 2%. This rate is less than half as high as the last peak in interest rates in 2006 (5.25%), and only about a third of the peak before that (6.5% in 2000). In fact, interest rates are still low by any historical standard.

One problem is that when (not if) the next recession comes, the standard tools that the government uses to fight a recession have already largely been used up. One tool is to lower interest rates, a monetary policy. In the last two recessions the Federal Reserve cut interest rates by more than 5%, but now it can only cut by less than half of that. The other main tool is to cut taxes and increase spending, as President Obama and the Democratic congress did in 2009. Their American Recovery and Reinvestment Act or ARRA was a combination of tax cuts and spending increases of about $800 billion spread over two years. The recession (which lowered tax revenues) and the ARRA and other economic stimulus boosted the Federal budget deficit by almost $1 trillion (one thousand billion). But with the Trump tax cut and increase in military spending leading to an almost $1 trillion budget deficit this fiscal year (2019), the government’s ability to fight the next recession will be weak.