Is it time for a reckoning in stocks?
Is it time for stocks to sell off? In light of the 10th anniversary of the collapse of Lehman Brothers last month, we should remember that it’s a mistake to be complacent about what could happen in markets. Extreme economic and financial events are far more likely to occur than we like to believe.
But the real lesson of Lehman is not so much that very bad things can occur — it’s that anything might. Investors should be mindful of the risk of further crises, but they should also keep in mind the possibility that things might turn out just fine.
This is hard to do. It’s far easier to think of ways that things might soon go wrong. The U.S. stock market is the most expensive stock market in the world currently, according to renowned Yale economist Robert Schiller.
The economy has enjoyed a long expansion — maybe too long. The S&P 500 hit its market bottom in March 2009, and since those lows, it has rallied 334 percent in the longest stretch on record since World War II without dipping into a bear market.
Perhaps the Federal Reserve will tip it into recession. The trouble in emerging markets may worsen. Meanwhile, China’s economy has slowed. President Trump’s numerous trade wars present another threat.
Often, the origins of a crisis can often be found in the response to the previous one. The Fed’s interest-rate cuts following the East Asian and Russian crises helped create the dotcom bubble. When that burst, the Fed slashed interest rates and fueled a housing boom and bust that did in Lehman Brothers amid the broader crisis. There is good reason to worry that the end of ultra-easy monetary policy in Europe, as well as the Fed’s unwinding of its $4 trillion balance sheet, will unsettle financial markets.
So how might it all work out? It is encouraging that a number of Fed governors seem anxious about the risk of tightening monetary policy too much. Emerging markets may be out of favor, but only a handful (like Turkey) are plagued by an over-reliance on foreign financing and inflation.
Interestingly, some market participants maintain that the threat of a trade war has reduced the likelihood of global recession because it has spurred the Chinese government to stimulate its economy sooner than it would have done otherwise.
Ultimately, no one knows what the future holds. It’s almost always the case that negative news gets the attention, and it’s quite possible that the naysayers are right. But precisely because we don’t know what will happen, investors would be wise to hold tight to a strategy that keeps them diversified and fully invested, especially considering the long time horizons for most investors’ financial goals.