Thank Goodness the Stock Market is Sliding. It’s About Time

Todd Stein

The S&P 500 has got its first bloody nose in years, dropping almost 5 percent since February 1.

Real estate stocks have fallen even farther. The largest real estate index fund has plunged 6 percent since February 1 and 10 percent this year.  

These selloffs are just the beginning. Investors expect the new Federal Reserve chair, Jerome Powell, to maintain or accelerate the pace of interest rate hikes. So they're pulling their money out of stocks, real estate, and other assets that fare poorly when interest rates rise.

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Some investors and market pundits are urging Powell to hike rates slowly, lest he trigger a recession. He ought to ignore them. A decade of rock-bottom interest rates has clobbered middle-class savers and distorted markets.

Quickly returning rates to their historic norms might cause a bear market or a short recession -- but it's the only way to preserve what's left of America's free enterprise system and bootstrap culture.

When the financial crisis hit in fall 2008, the Fed cut rates to zero to stimulate lending and investment. Sharp rate cuts in the middle of a recession make sense. But what followed was unprecedented -- the Fed held rates at zero until December 2015, even though the recession ended in 2009.

The Fed's decision has caused immense collateral damage -- especially to baby boomers. Seniors and those nearing retirement have traditionally invested their savings into safe assets, such as certificates of deposit and government bonds.

Those assets have generated near-zero returns in recent years. One-year CDs currently pay about 1.8 percent in interest -- meaning depositors make nothing after accounting for inflation, which is supposedly running at 1.8 percent. Many economists feel the government's models underestimate the true inflation rate -- so people may have actually lost money by keeping their savings in CDs.

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Traders and financial professionals work on the floor of the New York Stock Exchange (NYSE) at the closing bell, February 2, 2018 in New York City. The Dow dropped 250 points at the open on Friday morning. The Dow plunged over 660 points on Friday, marking its biggest one day plunge since June 2016 following the Brexit vote. Drew Angerer/Getty

Meanwhile, 10-year Treasuries currently yield about 2.8 percent -- and haven't yielded more than 3 percent since 2013.

These low rates of return have left retirees with two choices: meet their spending needs by eating into their principal, or seek better returns from riskier investments like stocks or junk bonds.

This week proves that no bull market lasts forever. Equities are inherently volatile and valuations are near all-time highs. Warren Buffett has long cautioned people that they "shouldn't own common stocks if a 50 percent decrease in their value in a short period of time would cause… acute distress."

"Acute distress" is certainly one way to describe what retirees would feel if their nest eggs halved in value.

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If the Fed hiked interest rates and caused 10-year Treasuries to return to their historical average yield of 6.24 percent, a married couple aged 56 could move most of their portfolio into 10-year Treasuries and see their retirement funds safely double by the time they turn 67 and qualify for full Social Security benefits.

A decade of low interest rates hasn't just hurt savers. It has also spurred a get-rich-quick culture in which investing for the long term is seen as a sucker's game. The resurgence in day-trading and house-flipping shows that people have grown to expect that asset prices will spiral ever higher. When that ceases to be true, the reckoning will be severe.

Ultra-low interest rates have also distorted career incentives for America's youth. A generation or two ago, the best and brightest would pursue careers in medicine, engineering, or science. The rewards of success accrued over a lifetime.

Now, many brilliant young people rush to get rich quick in finance instead. They rely on complicated financial instruments and cheap borrowed money to make large profits as quickly as possible.

Cheap money is one of the classic contributors to economic bubbles: speculators drive up prices and hope to sell before the bubble pops. Inevitably, someone is left holding the bag. It's better to start deflating asset bubbles now rather than let them get bigger and dramatically burst.

Returning interest rates closer to their historical levels would temporarily slow economic growth and might even cause a brief recession. But recessions, while painful, help make the economy healthier in the long run.

Just as a fire helps kill off old growth and allows a forest to regenerate, a recession would kill off cash-hemorrhaging "zombie" companies that survive thanks to cheaply borrowed money. Higher rates would force investors to reallocate capital to productive companies that boost long-run economic growth and job creation.  

It's time our nation's monetary policy once again encouraged the habits of thrift, industry, and savings that built America.

Todd J. Stein is a principal of Braeside Capital, L.P., a Dallas-based private investment partnership.

This article was first written by Newsweek

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