I see two problems with the term “correction”. Yes, there is a sense in which any change in market prices is a “correction”, as with new information the previous price becomes inappropriate. But that’s equally true of an increase or a decrease in market prices. In contrast, the term market correction tends to be used asymmetrically, for price declines but not price increases.
The second problem is that market corrections are often viewed as a healthy change, like correcting a mistake that you made on an exam. In fact, the vast majority of stock market declines reflect unfavorable developments. Only in rare cases where price declines reflect events that are good for the country but bad for business can we say that a stock market decline is a sign of health. And stock price declines that are due to trade wars are certainly not in that category. Here’s Bloomberg:
Treasury Secretary Scott Bessent, a former hedge fund manager, said he’s not worried about the recent downturn that’s wiped trillions of dollars from the equities market as the US seeks to reshape its economic policies.
“I’ve been in the investment business for 35 years, and I can tell you that corrections are healthy, they are normal,” Bessent said Sunday on NBC’s Meet The Press. “I‘m not worried about the markets. Over the long term, if we put good tax policy in place, deregulation and energy security, the markets will do great.”
Market prices tend to roughly follow a random walk. That means a decline in the current price of stocks also represents a decline in the future expected value of stocks. The stock market is forward looking, and already incorporates any expected futures gains from trade wars. If we are not now seeing those gains reflected in the stock market it is probably because they do not exist.
Back in 1930, President Hoover agonized over whether to sign the Smoot-Hawley tariff bill. On a Sunday in late June, he decided to sign the bill, despite receiving a letter signed by over 1000 economists opposing the tariffs. The next day, the US stock market suffered its largest one-day decline of 1930. Those waiting for a rebound in the market–the Scott Bessents of 1930–had a long wait. Stocks didn’t regain June 1930 levels until mid-1955, a quarter century later.
To be clear, I’m not making any predictions about the market, as President Trump has a habit of advocating trade wars and then backing away at the last minute. In addition, many other factors beyond tariffs affect the stock market. I still own stocks and it wouldn’t surprise me if they bounced back. Nonetheless, it is dangerous to assume that your policies are beneficial in the long run, when the markets suggest exactly the opposite.
Update: It seems the markets agree with me:
U.S. stock futures declined Sunday after Treasury Secretary Scott Bessent said he’s not worried about a market downturn, despite a miserable stretch for Wall Street.
READER COMMENTS
David Seltzer
Mar 16 2025 at 7:06pm
Scott: Bang on!! I have always disliked the term “correction.” To your point, markets impound information in prices and price changes instantaneously. Asset prices are, as you know, the present value of expected future cash flows discounted by some stochastic discount factor, (SDF). I too managed a hedge fund and quite successfully. I never thought a severe decline in market prices was healthy. Someone please explain to me why a price decline in my home is healthy? The problem, as I see it, is the Knightian uncertainty DJT has caused in the markets. Since it’s virtually impossible to insure against uncertainty, One becomes far more risk averse and scrambles to cash or safer securities like treasuries. Curious note. When DJT championed tariffs during his campaign, Warren Buffett got into 350 billion in cash.
Knut P. Heen
Mar 17 2025 at 8:07am
The opportunity cost of capital, David. It is cheaper to live in your house if the price drops. Housing is primarily consumption, not investment.
Matthias
Mar 17 2025 at 8:58am
A decline in opportunity cost of capital would be useful only for people who don’t already own a home.
Otherwise, the opportunity cost goes does exactly in proportion to how much the value of your home goes down. Obviously.
David Seltzer
Mar 17 2025 at 9:26am
Yup!
Knut P. Heen
Mar 18 2025 at 1:04pm
This is incorrect. You can buy more stocks if you sell an expensive house than if you sell a cheap house. By living in the house you give up the return on the stocks including the dividends. Sometimes you may be lucky and the price of your home increases more than the stock market, but that is certainly not the rule. Even with the recent decline, you would have done better buying the Tesla stock than a Tesla car one year ago. Buying a house is similar. The house is consumed over time. It is the land underneath the house that increases in value.
David Seltzer
Mar 17 2025 at 9:11am
Knut, I see your point. Yes. Living in my home is primarily consumption but not 100%. But…during the recession 2009, equity in homes fell below mortgages financing them. People stopped paying monthly payments. I would never exercise an out of the money call, but I sure as hell will exercise a deep in the money put. That’s when the investment part of owning a home becomes apparent.
David Seltzer
Mar 17 2025 at 12:01pm
Knut: For years years I’ve been trying to learn how to think like an economist. On line courses. youtube videos and extensive reading. My point, I didn’t consider that owning a home was consumption. I thought of it as an investment. My education and hopefully a deeper understanding of these nuanced concepts has been greatly enhanced by your comments, the comments of others and of course the authors. Sumner, Murphy, Henderson, et al. Thanks.
Jose Pablo
Mar 17 2025 at 1:27pm
David,
Here’s how I see it, in case it’s helpful to you.
Your “need to consume shelter in the future” is a liability. The value of this liability is equal to the net present value (NPV) of all your future payments related to housing.
If you own your home, it is an asset. If the home you own is (more or less) the shelter you want to consume, then the value of this asset is roughly equal to the value of the liability above.
Now, if the price of your house increases, your asset has undoubtedly become more valuable. However, at the same time, your “need to consume shelter” liability has increased by the same amount.
So, both things are true at the same time: your asset is more valuable, but your net worth remains unchanged.
This perspective leads to some (potentially) interesting insights:
Changes in the price of the home you own and live in do not affect your net worth. However, for instance, choosing to downsize, by reducing the NPV of your “need to consume shelter” while keeping the market value of your home intact, does make you wealthier.
You can “cover” (so to speak) your “need to consume shelter” liability with any other asset (e.g., stocks). In principle, the best asset for doing this would be the one with the highest expected return. But, you need to keep in mind, that the home you live in and own provides an almost perfect hedge against changes in the value of your liability, whereas higher-yielding assets (such as stocks) do not. They leave your net worth more exposed to volatility driven by fluctuations in real estate (or your asset) prices (or by the unpredictability of a landlord).
Hope this helps!
David Seltzer
Mar 17 2025 at 7:09pm
Jose, thanks for your thoughtful comment. Your premise statement, “Your “need to consume shelter in the future” is a liability. The value of this liability is equal to the net present value (NPV) of all your future payments related to housing.” That helps a lot. The NPV of future payments to consume shelter as a liability must be my opportunity cost. For example, I would forgo alternative shelter in the form of a house boat or motor home. For that to obtain, the NPV of future payments for my forgone housing options would be identical to the NPV of future payments of my current home. Assume I purchase a home for $500,000. 20% equity. $400,000 mortgage. 30 years rate is 6.5% per. Monthly mortgage payments are $2400. (liability). NPV of future payments is $72,000. My opportunity cost is forgoing a lovely yacht or motor with equal numbers. Right track here? Again, Thanks Jose.
David Seltzer
Mar 17 2025 at 7:56pm
Jose Pablo. Huge mistake. NPV is 863,298. NOT 72,000. Apologies.
David Seltzer
Mar 17 2025 at 8:04pm
Jose, apologies 2.0. NPV is 380,497. I used the wrong monthly rate on my previous calculations.
Mactoul
Mar 16 2025 at 10:27pm
Doesn’t prosperity consist in things becoming cheap and not in getting expensive?
A general deregulation in construction as it recommended — will it not decrease house prices and isn’t it better for the country?
Scott Sumner
Mar 17 2025 at 11:39am
It depends on why things get cheap. More supply is generally good–less demand, not so good.
Never reason from a price change.
David S
Mar 17 2025 at 1:17am
As one of the little people it’s quite troubling when the Dear Leaders start making statements about how collective suffering is a good thing. Did Pearl Harbor just get attacked? Are we at war with Oceania? Should I buy the dip on Tesla stock because Trump will order airstrikes on the factories of Chinese electric car companies?
Bessent identifies improvements in three areas that will supposedly usher in an era of iron rice bowls: Taxes, deregulation, and energy. I could see how land-use regulation reform could improve this country, but since zoning is controlled at the local level I don’t see Trump taking time away from his golf schedule to draw attention to this issue.
Mark Brophy
Mar 17 2025 at 6:03am
Maybe Canada will stop selling electricity to the United States. Maybe waging war against Canada is as foolish as waging war against Russia and Gaza. Maybe owning stocks is foolish because they’re overpriced and the future is bleak. Gold has increased 50% in the last year. Maybe gold is the new Bitcoin or Nvidia and will increase 50% annually indefinitely.
Jose Pablo
Mar 17 2025 at 7:48am
The markets agree with me
Markets are not always the best source when it comes to validating opinions.
However, what is already painfully clear is that Trump’s policies, or whatever one chooses to call what he is doing, are already harming the real economy.
Uncertainty is bad for business. A lack of clarity about future labor availability and input costs is a serious problem when you have to put your own money on the line. Trump has created precisely that, on a massive scale.
At this point, the damage is already unavoidable, regardless of what happens next. And if I had to place a bet, which is what entrepreneurs and markets do all the time, I would wager that things are only going to get worse from here.
Andrew_FL
Mar 17 2025 at 8:44am
This is a logical contradiction.
Scott Sumner
Mar 17 2025 at 11:40am
Just the opposite. An efficient forward looking market is inevitably unpredictable, close to a random walk.
David Seltzer
Mar 17 2025 at 12:13pm
Scott: Good point. When I was asked about my primary function managing a hedge fund, my response was “I manage risk as markets are volatile and mean reverting. I don’t know any more than that. I just can’t predict the future very well. If I could, my alpha would be substantial. As an aside, I calculated our firm’s alpha over several time horizons. The average was zero. In effect I was earning market returns adjusted for risk. Pretty much what CAPM tells us.
Andrew_FL
Mar 17 2025 at 2:20pm
This response is as baffling as the original statement. Random behavior cannot be forward looking, unless you believe the future itself is random. To behave randomly is to take no account of the future or the past, or anything for that matter, but to simply behave randomly.
Scott Sumner
Mar 18 2025 at 1:12pm
Markets respond to unanticipated shocks. I’d encourage you to read an article explaining the EMH.
Jon Murphy
Mar 17 2025 at 11:29am
Those making the “market correction” argument now are mainly doing it as an ad hoc explanation, rather than something reasoned out. In this case, the argument is especially weak.
Scott Sumner
Mar 17 2025 at 11:41am
Yes, the same people cited the strong market of 2017 as evidence that Trump’s policies were working.
Jon Murphy
Mar 17 2025 at 11:50am
And the bump after the 2024 election that Trump was going to be good.
Jose Pablo
Mar 17 2025 at 2:18pm
This demonstrates that the recent decline in stock prices is indeed a true “correction”!
The initial belief that “Trump was going to be good” is now being adjusted.
So, Besset is right, correcting that initial misconception is a healthy development.
Scott Sumner
Mar 17 2025 at 2:36pm
Healthy for the market, not the country. 🙂
Thomas L Hutcheson
Mar 17 2025 at 8:42pm
The realization that the combination of trade and immigration restrictions and deficits is not good for the country is good for the country. 🙂
Jose Pablo
Mar 18 2025 at 10:17am
But it’s only a first step, Thomas. And a first step not taken by the decision-makers.
The real lesson here, I believe, is this:
“Never entrust important matters to the government—even a government that thinks like you or follows your advice. Governments change.”
As practical applications:
People on the left believed that the best way to address climate change was through government-imposed measures. They sure regret it now, realizing a better approach would have been to establish a framework that empowers individuals to act, a “Coasian solution”.
People believing it made sense to beef up the armies of freedom now see the unsettling reality of Germany (or France) ramping up military spending, building forces that, at any moment, very easily, could fall under the control of a radical nationalist government. Or watching Canada and Denmark expand their militaries, not in alliance with, but in defense against, what was once the “leading army of the free world”
“I’ve seen things you people wouldn’t believe…”
Knut P. Heen
Mar 18 2025 at 1:25pm
I think it is always useful to separate the economics from the finance. Tariffs are bad. The fact that the market adjust stock prices downward in response to hikes in future tariffs is both good and healthy. The disease is the tariffs. The stock market reaction is only a symptom.
Comments are closed.