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If you are a daily follower of the stock market, the past two days have been unsettling. The nearly 7% drop in just thirteen trading hours certainly sent shock waves to the broader investment community, bringing back familiar fears for those who still have memories of 2008.
The shock is understandable. The market hasn't dropped like this since 2016 and certainly rained on the parade of positive returns that investors have seen during the first few weeks of this year. If you have read these commentaries before, this is where you are probably expecting to hear something to the effect of "these things happen," or "this was bound to happen," and certainly, "this is no reason to panic." And yes…all of that is true. Still, it is important to understand why it happened and what it may (or may not) be forecasting.
First, why did it happen? Ironically, part of the reason for the drop is something most people would see as a good sign—growth in wages. Sounds strange, right? Why would faster than expected wage growth send investors scurrying? The answer is pretty simple. As most reading this are likely aware, we have been in an extended period of low interest rates in this country—nearly a decade, to be exact. For most of the last ten years, the Federal Reserve, which controls interest rates, had been gun shy about raising rates and stunting the economic recovery from the Great Recession. Over the last two or three years though, the Fed has started raising rates, recognizing that rates need to go up in an economy that has recovered (which by most measures, ours has, and then some).
The Federal Reserve has, rightly in our opinion, tempered its raising of rates, doing so a quarter-point at a time as to not send the economy, and specifically the stock market, into an inflation-related shock. Spiking inflation would most definitely have a negative impact on U.S. investment markets, and spiking interest rates would destroy bond markets. It is a lose-lose proposition, which is why the Fed has avoided it.
Then, wage and job reports came out last week. Wages began growing at a faster pace than expected, unemployment remained low. These reports, which are great news for the American worker, have begun to make the American investor very uneasy. If these wage reports are part of a trend, it could force the Fed to raise rates more than previously expected…which could send inflation higher, more quickly than expected…which could signal a coming correction in the market. These factors, along with weaker-than-expected technology sector and energy sector earnings, initiated the rapid stock sell-off. Couple that with rising bond yields (meaning that investors could find better returns in bond markets), and you have the recipe for a pretty difficult couple of days.
What does it all mean? The truth is, we don't know yet. Two days certainly do not make a trend. Corrections of 5% to 10% can happen for very small reasons or no reason at all and do not signal that start of a broader recession. By many leading indicators and economic measures, the fundamentals of our economy still appear stable, if not strong, meaning that we do not yet have reason to believe that we are headed for disaster.
If we are being honest, last Friday was not the first time that signs started to point towards some impending market struggle. Recent meteoric rise in the market and the incessant credit-taking that happens in Washington (Presidents don't deserve much credit or blame for the market…ever) may have made last Friday seem like news, but if anything, it simply cements what we have known for a very long time—we are much closer to the end of this cycle than the beginning, or even the middle. It is why clients may have seen some pullback in U.S. equity investments in their portfolios, despite a raging positive market.
While we are being honest, let's also keep some perspective. Sure, 1,700 points over two days in the Dow Jones sounds like a tremendous loss. But it really isn't. On one day in September 2008, the Dow went down fewer points (by more than 200) than it did yesterday, but had nearly twice the impact on investors. The same thing happened in 2001...except that time the market only went down by half as much as it did on Monday and still had twice the impact. That is because the Dow Jones was at just over 11,000 and 9,600 respectively when it happened.. At the start of this market disruption, the Dow was north of 26,000. That is a long-winded way of saying that one of the reasons it is easier (and less significant) to lose 1,000 or 2,000 points is because of just how long the market has gone up without interruption.
It is entirely possible that there is some bad weather headed our way. In the same way that we were overdue for a small correction, we are (and have been) overdue for a more significant market decline. But we are not there yet. And like always, we do not allow one or two days of returns to drastically change long-term strategy. No amount of fear, greed, positivity or negativity should do that. But as concerns of a market correction begin to creep into the news more and more (which we anticipate it will), it is important to remember that when you have had so much sunshine for so long, it is bound to rain. And after the rain, the sun will come out again.