By Ken McCarthy, Principal Economist
The stock market has become very volatile following the employment report earlier this month leading to the largest single day point decline in history on February 5, 2018.
Our economics and research teams are monitoring this closely. As Kevin Thorpe our Global Chief Economist noted in his webinar on the U.S. economic and real estate outlook earlier this year, the stock market has become overvalued and a correction is overdue. So while the size of the movement in equity markets has been unusual, the correction itself is not a surprise.
There are reasons to ignore the stock market’s volatility and reasons to pay attention:
- Ignore it because the economy is healthy – we have seen these kinds of rapid movements in equity prices several times during the current expansion and the economy always powered through them.
- Pay attention because one important driver of consumer spending has been the wealth effect as people feel richer and spend more because of it. If the wealth effect goes away will consumer spending falter?
- Ignore it because even with the large point declines of the past two weeks, equity values today are still higher than they were in late November. In percentage terms, the drop just barely reached the level of a correction.
- Pay attention because the volatility may impact confidence. Households and businesses are extremely optimistic right now and if that confidence is dented it could impact business hiring and investment as well as spending by consumers.
- Ignore it because the stock market is a bad indicator of the future. As Nobel Prize winning economist Paul Samuelson once said: “The stock market has forecast nine of the last five recessions.”
- Pay attention because we are in uncharted territory as far as financial markets are concerned. The Federal Reserve engaged in an unprecedented effort to stimulate and support the economy over the last 10 years. It is now unwinding that support gradually and it is not at all clear how these changes will impact businesses, households and most importantly, financial markets.
So where do we land? Cautiously optimistic. The economy is the same today as it was two weeks ago before all this started. In fact, it was arguably a positive economic report (the strong job and wage growth of January) that triggered the decline. But the situation bears close monitoring. Extreme volatility is never good because it reduces certainty and therefore can make people and businesses more cautious.
Overall, we expect the current volatility to pass and the markets to settle into a more normal pattern of activity.
We do not think the stock market’s gyrations will have a material impact on real estate values. For that you have to look at the bond market. The 10-year Treasury note reached a yield of 2.87%, its highest level since January 2014. Higher Treasury yields may prompt some investors to demand higher returns from other assets including real estate. We believe that a steady, moderate increase in long term rates will be readily absorbed in the market, but if yields spike sharply higher it could prompt real estate investors to pause until there is more clarity.
Ken has been with Cushman & Wakefield since August 2006. As Principal Economist, he works with the Chief Economist on Cushman & Wakefield’s U.S. economic position and presents it to the public. As Applied Research Lead, Ken is responsible for preparing cutting edge research about the outlook for commercial real estate in the Americas.