In the run-up to the 2016 presidential election, the conventional wisdom on Wall Street was that, if Donald Trump won, the stock markets would tank. This was, after all, the man whose campaign was defined by its unpredictability, its populist rhetoric against Wall Street and D.C. elites, and its frequent rants against the immigrants, outsourcing, and free trade deals that many American industries rely on; it seemed unlikely the economy would stay stable under his leadership.
With the exception of brief declines on election night and the following day, that crash didn't happen. Instead, Trump's surprise victory ushered in a market that, for all of 2017 and the first few weeks of 2018, seemed to just keep steadily going up, and up, and up. During the first three weeks of January of 2018, the S&P gained over 6 percent; it was, in the words of a CNBC reporter, the market's "best start to year in more than three decades."
Despite the fact that the stereotypical Trump voter—blue-collar, "forgotten," struggling, living in an economically distressed area—likely doesn't own any stocks, the president nonetheless took great pride in this trend and frequently pointed to it as a sign of the economy's health, as he did in a tweet in early January:
And then, at the very end of January, something strange started happening: The market stopped it's long, steady upward climb, and it started jumping wildly all over the place. At one point in February, the major stock market indices were all down over 10 percent from recent highs. While the markets have since regained much of their lost ground, the jitters continued last week, and many experts expect to see more volatility in 2018.
We asked Rob Johnson, the president of the Institute for New Economic Thinking and a former chief economist of the United States Senate Committee on Banking, to explain the underlying causes of the market volatility, and what it all means for average Americans.
Why did the markets start the year so strong?
There is very often a pattern at the beginning of the year where investors all get on the train on something together, and the velocity of the rise in the market, or whatever the train is, usually proceeds pretty aggressively through the month of January.
And what changed?
I'll use the old Road Runner cartoon as an analogy—Wiley Coyote runs off a cliff, then stops and looks down and realizes there's nothing under him. There's always a kind of musical chairs game where everybody has been riding this momentum of having picked the right theme, but nobody knows when to get off the train. And then when one person, or a few people, gets off the train, those price declines make everybody wake up to the fact that, like Wiley Coyote, they're going to fall off the cliff. And then people compete to get out. It's like yelling "fire" in a crowded theater.
There are a lot of theories floating around about what caused the sudden change in conditions—it sounds like you attribute it partly to a realization on the part of some investors that the market was overheated?
I think, in the second half of last year, you had all these promises of deregulation, and promises of tax reform, and promises of infrastructure projects—all of these things were positive for expectations of future profitability. You can understand the long upward trend—these policies benefit stock holders and big businesses.
But when the market starts to take on a life of its own, like it did in early January, even the most optimistic investors say, "While the scenario's good, the prices are getting ahead of how good it is." That's what creates the Wiley Coyote balloon: You realize you don't have solid ground underneath you.
Another theory floating around is that the correction occurred because investors started to worry about lower unemployment and higher wages leading to higher inflation and interest rate hikes. What's your take on that theory?
Given Trump's campaign promises, he is somewhat obligated, if he's tactically smart, to say, "Well, now we're going to get unemployment down to 3 percent." He's talking to his base when he says that.
And what economists think is that if you get unemployment down to 3 percent, inflation's going to rise, and interest rates are eventually going to go up. And when people start talking about inflation scares, that makes people nervous. If investors are thinking that either interest rates are going to go up or profits are going to get compressed, those are both bad news for investors.
Let's talk a little bit about who should care about all this market volatility. Only half of Americans are invested in the stock market at all. And a lot of those people invest for the long-term (in retirement funds, for example), so these short-term ups and downs don't affect them much. If you're just an average person—you're not a day trader or a hedge fund manager—whose life is mostly unaffected by these day-to-day fluctuations, why should you care about this volatility?
I think what people should care about is the backdrop against which these market increases, and the subsequent volatility, is occurring. And the backdrop right now is that inequality is very, very high, and wealth is really concentrated in the hands of the 1 percent, and others are really struggling, and they have been for long periods of time.
And we just passed a tax cut, which explains some of the good market performance in 2017, and used our fiscal capacity as a country in a way that did very little to address the pain of the American public and very little to head off the notion of social protest or social insurrection/discontent. We could have constructed a tax cut that stimulated the economy, distributed the benefits much more broadly, and we didn't. And there's very little reason to believe the trickle down is going to work and we're going to get broad-based prosperity. We've just used our fiscal capacity for the military and for tax cuts for the wealthy.
Now the question is: Should you care about that? I think we should all care about the health of the American republic, and I think the tax bill is a symptom of a dysfunctional system, and portends more turmoil in the future.
Obviously, if you aren't among those people who are in that wealthy segment, that anxiety you were feeling during the 2016 campaign persists. And if you are among the segment who holds a lot of wealth, the incoherence of our social system may be offset in the short term by the windfall of money that you got. But the storm clouds are still on the horizon.
This interview has been edited for length and clarity.