It had to happen. When high flying financial markets are ready to fall, anything can trigger it. Who could have predicted that this time it would be a virus? In an earlier age, it could have been Fed Chair Alan Greenspan rumored to have a hangnail. That’s an exaggeration, but not by much.

During the week ending Feb. 28, the Dow dropped a record 3,500 points, landing 15% lower than its all-time high; the S&P dropped to 13% lower than its all-time high. Three major indices, the Dow, S&P and NASDAQ, fell to what financial professionals call “correction mode.”

Swings in short term financial markets are as much psychological as economic. They characteristically overshoot both on the way up, and on the way down. As fear is a more powerful motive than hope, markets generally fall faster than they rise, hence last week’s precipitous decline after the trigger set it off.

As the long term bull market began under the Obama Administration, and continued under the Trump Administration, reaching record highs, opinions varied widely. Some warned to be wary of, and expect, an imminent decline; many simply urged “caution;” and some, mainly Trump fans, counseled that with a “strong economy,” we should expect the bull market to continue.

President Trump is, to put it euphemistically, an “unusual” president in many ways. Previous presidents, Republican and Democrat, realizing that financial markets are out of their control and can turn on a dime, refrained from measuring their performance by the stock market. In contrast, Trump believes that the stock market defines the economy, insisting that he is solely responsible for those recent record highs.

Reasons for that long term bull market include strong corporate profits, rising employment and low interest rates. The temporary sugar high and fiscal pull of the Trump/Republican 2017 tax bill added to the buoyancy of the economy when it wasn’t needed — along with its negative longer term effects of exacerbating after-tax income inequality, and increasing the public debt that will make fighting the next recession more difficult.

The Fed’s three interest rate cuts under Fed Chair Powell, billed as “preventive medicine” during full employment and rising stock markets also contributed to the continued bull market. They were not needed, and should have been reserved for when they will be needed during the next recession. 

Previous to the market’s decline, there was an indicator that suggested caution, the price-earnings (P/E) ratio that indicates the price of a corporation’s stock relative to its earnings. A P/E ratio, depending on the industry group, is considered to normally average somewhere around 15. In January 2020, P/E ratios of the S&P were around 20, and higher, sometimes approaching 25. Although the P/E ratio is not the sole criterion on which to make decisions, it indicated that highly priced stocks were more likely to fall than rise in the near term. 

Nevertheless, short term fluctuations of stock prices are normal, less consequential than a decline that turns into a bear market. Whether this decline turns into a longer term bear market depends on the unpredictable economic consequences of the coronavirus.

When financial markets decline, Trump declines ownership — “the buck stops anyplace but here.” Presidential candidate Bernie Sanders and the rest of the Democratic candidates, all tarred as “socialists,” are a convenient foil. Historically, the economy and financial markets have performed as well or better under Democratic administrations than Republican, but the myth, nursed by the corporate media, persists that Republican administrations are “better for the economy.”

Trump blames the media, along with Democrats, as “politicizing the coronavirus scare,” even as Trump himself politicizes it. Placing VP Pence in charge of managing the situation and having public health professionals filter public announcements through him is more like managing public relations than dealing with the situation itself. Don Junior’s accusation of Democrats “wishing for numerous deaths so that they can defeat Trump” is politicization in the extreme. It was Trump who early on cut funding for the Center for Disease Control.

Trump also lays blame on Powell, his Fed Chair appointee, insisting that “Our Fed should start being a leader.” Powell had already cut interest rates when such action was not needed. Revealing once again his ignorance, Trump insists that with these unstable financial markets, Powell should come to the rescue and continue cutting rates. The Fed’s mission is to deal with employment and price levels, not nursing financial markets. The Fed should reserve its few remaining tools for the next recession that could result if this coronavirus situation gets far more serious. 

Economists can’t predict how the coronavirus scare will turn out. But they can predict that if it is not handled well, and especially if it continues to become more serious, the economic consequences could lead to worldwide recession.

On the demand side, reduced travel, cancellation of public events, and reduced attendance of restaurants and amusement parks, all result in reduced economic activity and income.

On the supply side, many production processes use components obtained through international trade — American producers depending on inputs from China, for example. Such supply chain interruptions result in reduced production with reduced employment, reduced income, and further reduced spending. Even if the Fed had more room to reduce interest rates, it is not equipped to solve problems involving interrupted international supply chains.

Opinions of financial market observers range from an optimistic “V-shaped” bounce, to the opinion of NYU Business Professor, Nouriel Roubini, known as “Dr. Doom,” predicting “global equities to tank by 30 to 40% this year.

As this draft is being completed, the Fed has just followed Trump’s wishes, cutting interest rates by one half percent. Even if it helps “Trump’s stock market,” a doubtful proposition, it does nothing to loosen international supply chains and compensate for reduced economic activity induced by the coronavirus scare. 

The Trump administration has done nothing to inspire confidence in its handling of this situation. 

— John Waelti of Monroe, a retired professor of economics, can be reached at jjwaelti1@tds.net. His column appears Saturdays in the Monroe Times.