By Elizabeth MacDonald

The Dow’s 354-point plunge Thursday was the worst drop since the presidential election. FOX Business Network stocks editor Elizabeth MacDonald weighs in below on what's behind the decline and what to expect when the market opens:

The markets overreacted Thursday on the Federal Reserve’s signal it may withdraw from its stimulus. Traders are seeing any downdrafts as a buying opportunity for lots of stocks, which still remain on certain valuation measures at their cheapest levels since 1954. Ending artificial stimulus is a good thing. Investors can better figure out which companies have solid earnings growth, it’s back to fundamentals. It will stop the artificial bubbles in commodities and emerging markets.
The Fed pullout is a sign the economy is getting stronger, that’s nothing to fear - and all of that is good for stocks. The Fed pullout is also causing a natural correction in overbought currencies and lower-quality corporate bonds. The point of the U.S. central bank’s intervention was to reflate assets, and the economy, including housing. But not all boats deserved to be floated higher (does the Fed now have a triple mandate, not a dual mandate, of inflation and job growth?).
For a month and a half now, Wall Street has been in an uproar about the Federal Reserve’s plans to scale back printing money to buy $85 billion bonds, as many on the Street fear a terrific bull market for the past four years is coming to an end. The Fed’s money has leaked into the stock market, as returns on things like bank deposits are microscopically low. That’s why, even with today’s downdraft, the market is still up about double digits this year, still in shouting distance of the record it hit on May 28. But here’s the back story to the “stop the market, the Fed wants to get off” routine: Even the most unreconstructed bull has to agree the markets may have gotten ahead of the economic recovery, the slowest since World War II. That’s why we have these emotionally wide trading swings. Even so, the Fed thinks the U.S. economy is recovering to grow at a 3% annual rate. With faster economic growth comes higher inflation in the form of higher prices, which increase corporate profits, which are good for stocks.
But not so good for borrowers are higher borrowing rates, which are pegged to the 10-year bond, already at a 14-month high jumping to 2.4%, which is still historically low. A 3% U.S. GDP growth rate means the 10-year bond yield should go up to 5%. That’s still low, too, historically. When this bond moves higher, so do loans pegged to it. And besides, the central bank has already said it will raise rates if the economy improves.
Housing is in recovery, but it’s now questionable whether a rate hike would put it back on its heels, since loan rate increases may force borrowers to get up off their seats and into buying houses, which is likely why new and existing home sales numbers have been improving. But again, the central bank’s coming slow-down was telegraphed already by various Fed governors who gave speeches indicating the central bank would make this move fairly soon, as unemployment came down to 7%, which the central bank thinks might happen next year. The jobless rate is down to 7.5% from 7.8% when the Fed ratcheted up its bond buying in September 2012.
Here’s what’s worth keeping in mind: Stocks are still cheap at 15.5 times earnings, which is lower than the 17.3 median since 1993, and lower than the average going back to 1954. Despite the Fed bond purchases, equity valuations generally haven’t moved higher. Stocks are multiples cheaper than when they were in bubble territory in the late 1990s, and in 2004. Companies have cleaner books, less accounting shenanigans, they’re making real profits. They are sitting on around $1.8 trillion in cash, which could be deployed in a market downturn to buy stocks on the cheap.
Also, a footnote: The Fed can always restart its bond buying again as it’s done before if the economy slows down, joblessness moves higher and inflation remains weak.    

Related Articles
  1. Active Trading Fundamentals

    Giants of Finance: Charles Dow

    Find out how this financial visionary helped everyday people enter the world of finance.
  2. Bonds & Fixed Income

    How Now, Dow? What Moves The DJIA?

    Find out how this index tracks market movements and where it falls short.
  3. Investing Basics

    Understanding And Playing The Dow Jones Industrial Average

    Learn strategies for investing in this price-weighted index and how to interpret its movements.
  4. Investing News

    Market Outlook: No Bottom Until 2017?

    These investing pros are bearish on the market in 2016. Will there be a bottom in early 2017?
  5. Chart Advisor

    ChartAdvisor for February 5, 2016

    Weekly technical summary of the major U.S. indexes.
  6. Investing News

    What Does the Fire Monkey Mean for Your Portfolio?

    The Chinese new year this year corresponds to the monkey, a quick-witted, playful, tricky figure that means well but has a penchant for causing trouble.
  7. Investing News

    Building a Case for the Bulls: 3 Opinions

    These three big names are bullish on the economy. Are there good times ahead?
  8. Fundamental Analysis

    5 Predictions for the Chinese Stock Market in 2016

    Find out why market analysts are making these five ominous predictions about the Chinese stock market in 2016, and how it may impact the entire world.
  9. Investing

    Will China Suffer a Fate Similar to That of the Soviet Union?

    Many parallels could be drawn between the former USSR and today's China, but the one similarity the CCP wants to avoid is the Soviet Union's collapse.
  10. Investing News

    How China's Economy is Now Like America's

    China's economy could take the global economy down with it; why that might be good news in the grand scheme.
  1. What causes a significant move in the stock market?

    There is a nearly infinite number of factors that can cause the stock market to move significantly in one direction or another. ... Read Full Answer >>
  2. What's the difference between the Dow Jones Industrial Average and the S&P 500?

    The major difference between these two indexes is that the Dow Jones Industrial Average (DJIA) includes a price-weighted ... Read Full Answer >>
  3. How can I use a regression to see the correlation between prices and interest rates?

    In statistics, regression analysis is a widely used technique to uncover relationships among variables and determine whether ... Read Full Answer >>
  4. What are the major laws (acts) regulating financial institutions that were created ...

    Presidents George W. Bush and Barack Obama, in conjunction with Congress, signed into law several major legislative responses ... Read Full Answer >>
  5. What are some of the limitations of run rates?

    Some limitations of a reliance on run rates include the occurrence of one-time sales, limitations on contracts, seasonality, ... Read Full Answer >>
  6. What are some real-life examples of the 80-20 rule (Pareto Principle) in practice?

    There are a number of practical applications for the 80-20 rule in diverse areas such as the distribution of wealth in economics, ... Read Full Answer >>
Hot Definitions
  1. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  2. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  3. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  4. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  5. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
Trading Center