What Forest Fires Have in Common with Market Corrections

February 05, 2018

 

So, what do forest fires and market corrections have in common? Hello. My name’s Paul Carroll. I’m the CEO and founder of Efficient Wealth Management, a boutique wealth management firm.

 

California and the western United States have been ravaged by forest fires. Significant research suggests that fire suppression actually builds up the undergrowth and results in even greater fires. Really, the best course of action is regular, controlled burns. Financial markets are very similar, in that correction suppression by the Fed or policy makers creates ever-increasing valuations. Ever greater pressure. And, eventually, ever greater corrections.

 

In the 2000s, Fed policy and regulatory failure led to extremely high valuations and an extremely painful market correction that resulted in subsequent quantitative easing, which was absolutely necessary to avoid a second Great Depression in 100 years. Today, equity markets are rich and bond yields are low. Economic growth and a $1.5 trillion tax cut in the face of an economy that’s really running at full capacity has led the Fed to accelerate the ending of the quantitative-easing policy.

 

In fact, the fear of potential inflation means it’s almost inevitable that there will be subsequent interest rate increases. Those higher interest rates, especially at the short end of the yield curve, will very likely result in a slowdown in the economy. They also will probably lead to a modest correction, and that’s almost certainly what we’re seeing the beginning of now.

 

Certainly, I hope so. Because a modest correction today, like those forest fires, means a release of the excess exuberance, a release of the pressure, and a reduced chance of a much more painful correction later this year or next year. It also will result in some wonderful rebalancing opportunities. We wish you the best of investing success. Thank you.

 

Sources:

 

Amadeo, Kimberly. “How an Inverted Yield Curve Predicts a Recession.” The Balance, 15 Sept. 2017, www.thebalance.com/inverted-yield-curve-3305856.

 

Chappatta, Brian. “Inverted Yield Curve in 2018 Is Taking Over Wall Street Outlooks.”Bloomberg.com, Bloomberg, 7 Dec. 2017, www.bloomberg.com/news/articles/2017-12-07/inverted-yield-curve-in-2018-is-taking-over-wall-street-outlooks.

 

“Greenspan Put.” Wikipedia, Wikimedia Foundation, 22 Jan. 2018, en.wikipedia.org/wiki/Greenspan_put.

 

“Irrational Exuberance.” Wikipedia, Wikimedia Foundation, 24 Jan. 2018, en.wikipedia.org/wiki/Irrational_exuberance.

 

Kuepper, Justin. “The Greenspan Put, the Bernanke Put and Other Central Bank Puts.”The Balance, 30 Dec. 2017, www.thebalance.com/greenspan-put-bernanke-put-central-bank-puts-1978864.

 

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