After a spectacularly successful 2017, the Dow Jones had a difficult 2018, ending with the worst December performance since the Great Depression. This turnaround has gathered a lot of attention but what is the reason behind it?
Firstly, there are some domestic macroeconomic issues. The current American upswing has lasted for a decade, making it unusually lengthy already. When the four recent rate increases from the Federal Reserve are factored in, there is genuine concern about the future of the American economy, particularly whether it can transition from a prolonged period of low interest rates.
Added to this, there is concern about economic performances outside the US. Of the major European economies, the UK is moving sideways thanks to uncertainty over Brexit; Germany has hit a bump; and Italy continues to stagnant, with long-term concerns about competitiveness, and short-term ones about political instability. The major worry is though China, partly as many view previous growth rates as unsustainable, and partly due to worries that a Chinese-US trade war will prove problematic for both countries.
Herein, lies a much larger point; that markets have not been effective at pricing in the medium to long term risk posed by the unprecedentedly erratic Trump administration. Delighted by talk (and action) of tax cuts and deregulation, the Dow soared in 2017, increasing by 25%. This was the financial upside of President Trump’s mercurial, transactional approach. Yet it was clear, even at the time, that this approach had significant downsides. Trade wars launched by presidential decree over Twitter; and Presidential criticism of Amazon, seemingly prompted by personal dislike of the CEO, hardly provide a stable long-term business environment.
These concerns moved front and centre in 2018 as the President openly mocked the Fed Chairman (amongst others). A more nuanced approach from investors at the start would have factored these issues in earlier, leading to a more modest 2017 increase and, consequently, a shallower falloff. Because of this link Trump’s first two years need to be considered together; an overall increase of 18% in that period gives a more realistic picture of the health of the leading stock index.