Stock index volatility likely reflects market correction, economists say

LAWRENCE — Illustrating the current market volatility, the Dow Jones Industrial Average and other U.S. stock markets whipsawed between gains and losses Tuesday. This follows last Friday's steep drop and Monday's record 1,175-point dip.

University of Kansas researchers of finance and economics are available to give a historical perspective on the market volatility.

George Bittlingmayer, professor emeritus in the KU School of Business, researches mergers and acquisitions, investment by business and how politics and regulation affect financial markets. He is the former Wagnon Distinguished Professor of Finance in the business school and previously served as an economist at the Federal Trade Commission.

"The Dow is down 8 percent from its peak in late January, but a stock market decline by itself is no reason for panic or concern. Financial history offers many examples of stock market declines that weren't accompanied by economic downturns," Bittlingmayer said.

Large drops in stocks that took place in 1987 and the year 2000 offer examples, while most of today's investors may likely only remember the 2008 downturn and recession that followed, he said.

"That downturn was caused by some very serious flaws in the financial system. Financial institutions like Bear Stearns and Lehman Brothers were seriously overleveraged, and many homeowners had mortgages they couldn't or didn't want to pay off when housing prices declined," Bittlingmayer said. "Back then, the stock market shot up as part of a bigger and more fundamental housing and financing bubble."

He sees a contrast with the recent stock run-up, likely resulting from investors getting a bit too optimistic.

"Arguably, stocks have been richly valued, but we don't have major dysfunction in the financial system. It's hard to say at what level the stock market is correctly valued," Bittlingmayer said. "However, an 8 percent decline such as we have seen or even a 15 percent decline from the peak is not the end of the world and still leaves long-term investors in very good shape compared to where they were a year ago or five years ago."

Bob DeYoung, the Harold Otto Chair of Economics and Capitol Federal Distinguished Professor in Financial Markets and Institutions, is a former Federal Reserve economist. He is a leading scholar on performance, practice and regulation in the banking industry. 

"Yes, this is a correction. Equities have been somewhat — though not drastically — overvalued for a while now. All that was lacking was an event to spur the sell-off and make the correction," DeYoung said. "There were two events: One, Janet Yellen's parting comment that the stock market is overvalued, and two, last week's jobs report that wages grew faster in December than expected, which increases pressure on the Fed to hike interest rates."

A 15 percent decline in the market could be "about right," he said. In relation to the Federal Reserve's recent monetary response, we are likely finally witnessing "act two," DeYoung said.

"The Fed created an incredible amount of new money and it knew it would eventually have to suck most of that money out of the economy but do so without raising interest rates so high that it cut off economic growth," he said. "Personally, I think the Fed waited entirely too long to do this. But then again, the Fed has been fighting against a stagnant economy and was not getting any help from fiscal or regulatory policymakers. Now that we are getting both fiscal stimulus — through the tax cuts — and regulatory relief, the Fed has more cover to tighten up. But it is walking a tightrope."

To arrange an interview with Bittlingmayer or DeYoung, contact George Diepenbrock at 785-864-8853 or gdiepenbrock@ku.edu.

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