Originally published in the New York Times on October 19, 2014.
Since September 18, the stock market has fallen more than 6%. An abrupt decline last week—after five years of gains—prompted fears that the market may have reached a major turning point.
Has a bear market begun? It’s a great question. The problem is that short-term market movements are extremely hard to forecast. But we live in the present and must try to understand what’s driving markets now, even if it’s much easier to predict their behavior over the long run.
Fundamentally, stock markets are driven by popular narratives, which don’t need basis in solid fact. True or not, such stories may be described as “thought viruses.” When they are pernicious, they are analogous to the Ebola virus: They spread by contagion.
Theories that seem to explain the stock market’s direction often work like this: First, they cause investors to take action that propels prices even further in the same direction. These narratives can affect people’s spending behavior, too, in turn affecting corporate profit margins, and so on. Sometimes such feedback loops continue for years.
The most prominent story since the September peak seems to be one of a “global slowdown” with associated “deflation.” Underlying this tale are deeper, longer-term fears. There is a name for these concerns too. It is “secular stagnation”—the idea that there is disturbing evidence that the world economy may languish for a very long time, even for generations, as the word “secular” suggests.
I did a LexisNexis count of newspaper and magazine mentions, by month, of the phrase “secular stagnation,” and I found that they have exploded since November 2013. And a Google Trends search shows a similar pattern for web searches for the phrase since that time.
Why? It’s probably because Lawrence H. Summers, the former Treasury secretary and Harvard president, used the phrase in a talk he gave on November 8 at the International Monetary Fund in Washington. Paul Krugman wrote approvingly about the talk in the New York Times nine days later.
Mr. Summers presented his secular-stagnation idea with uncharacteristic diffidence: “This may all be madness and I may not have this right at all.” But his talk seemed to release a thought virus.
Nations’ periods of slow growth can indeed last for decades. But why predict something like that right now, and generalize this prediction for the whole world? Here we do not find consensus, only ideas whose relevance is hard to judge. Some people say a theory of John Maynard Keynes—known as the “underconsumptionist theory” because it says people inherently underspend once they become prosperous—is taking hold. Others say investment opportunities offer lower—maybe even negative—returns because the economy no longer requires so much heavy machinery. Still others say that an aging population is a drag on growth, or that the financial disarray left by the 2007-09 crisis is re-emerging. All of these theories have a certain plausibility but hardly offer reason to expect a major turning point in the market right now.
The great economic historian Robert Fogel, who died last year at the age of 86, wrote in a 2005 paper that he was surprised by the resilience of scholarly attention to the secular-stagnation theory. He found that the term began to be used in 1938, during a time of world economic despair, and that its currency grew rapidly, hitting a peak in the 1940s. Lively debate on the topic endured in the 1980s, he noted, though the discussion eventually decayed to almost nothing by the 1990s.
There is little talk about secular stagnation in scholarly circles today. The recent chatter has centered in the news media, in conference panel discussions and in the blogosphere.
We can contrast this secular stagnation story with the narrative that drove down the stock market in 2011. By May 10 of that year, the Standard & Poor’s 500-stock index had already doubled since its financial-crisis bottom on March 9, 2009. And then the index fell by about 20 percent from May 2 to August 9.
What set off that decline? It had to do with a different thought virus: the worry that Congress wouldn’t raise the debt ceiling in time to prevent the United States from defaulting on its debt. The nation didn’t default, but on August 5, 2011, S.&P. downgraded the national debt for the first time.
While reports on this drama were alarming, it’s not obvious why they should have caused such a sharp market decline. Clearly, consumer confidence fell. And for both individual and institutional investors, my own crash confidence index, based on questionnaire surveys conducted by the Yale School of Management, dropped almost as far as its record low at the worst of the financial crisis in 2009. People worried that stock prices would fall. The “expected” component of the Michigan Consumer Sentiment Index dropped lower than at the worst of the financial crisis in 2009.
Why was the default story so virulent? The Michigan Consumer Sentiment Report for July 29, 2011, said that although respondents might not have understood the issues surrounding the national debt, they were hearing “repeated warnings of ‘dire economic consequences,’” and because of their experiences were “keenly aware of the grave consequences of excessive personal debt.” And there was much talk that a first federal default would have been an epic humiliation—or so it was being depicted at the time.
But that narrative ended when Congress raised the debt ceiling. The stock market soared again, once the news stopped reinforcing that fear of dire consequences.
The current secular-stagnation story is less dramatic than that of the debt crisis. But because it’s so vague, the negative feedback loop can’t be resolved as neatly. The question may be whether this thought virus mutates into a more psychologically powerful version, one with enough narrative force to create a major bear market.