To paraphrase Ernest Hemingway, stock market shifts occur “gradually, then suddenly.” This has been evident recently as the market has transitioned from large-cap technology to other sectors. Following the latest jobs report, global stocks saw a sharp pullback due to concerns over the timing of Federal Reserve rate cuts and a weakening labor market. Financial markets are on edge as investors adjust to these changes.
The Nasdaq has now entered correction territory with a 10% decline from recent highs, while the S&P 500 has fallen 8.4% from its peak three weeks ago, and the Dow has seen a somewhat more modest decline of 6.1%. The VIX, or market’s “fear gauge,” has surged to its highest level since early 2023, and the 10-year Treasury yield has dropped below 3.8% from 4.7% three months ago.
Despite current concerns, macroeconomic conditions such as inflation below 3%, low but rising unemployment, falling interest rates, and significant stock market gains are what investors had hoped for at the start of the year. Investors need perspective to navigate these volatile markets and achieve their financial goals.
S&P 500 earnings are projected to grow 13% over the next 12 months, with more than half of its sectors anticipated to grow earnings by double digits. Long-term earnings drive stock market returns, so the economy’s overall health is more crucial than short-term trading activity.
Concerns are growing about potential Fed policy mistakes. The Fed has kept rates unchanged for over a year, seeking “greater confidence” that inflation is returning to its 2% target. However, this focus has led to a weakening labor market, sparking fears of a “hard landing.”
The Fed’s focus has shifted to the labor market. The latest jobs report showed the economy added 114,000 new jobs in July, below the consensus estimate of 175,000. Unemployment rose to 4.3%, the highest since the pandemic, but still low from a historical perspective. One reason economists are concerned about this increase in unemployment is an economic indicator known as the Sahm rule, which predicts the onset of recessions based on the trend in unemployment.
In fact, the very definition of a recession depends on the state of the job market.
However, higher labor force participation and immigration, both positive factors, contributed to rising unemployment. Both sides of the Fed’s mandate—maximum employment and stable prices—now point to a September rate cut, though some worry the Fed has waited too long.
There have been several historical instances that could be called “soft landings.” Perhaps the most notable occurred from 1994 to 1995 under Fed chair Alan Greenspan when the Fed doubled the federal funds rate from 3% to 6%. Inflation remained under control and the economy continued to grow, avoiding a recession. Despite the positive outcome, this was a harrowing time for investors since it resulted in the worst bear market for bonds up to that point.
Historical hard landings, on the other hand, have often been the result of policy missteps rather than just sub-optimal timing. The Great Depression, for instance, was worsened by the Fed’s decision to tighten monetary policy at a time when expansion was needed.
Investing is about both returns and managing risk. Investing is never a sure thing. Investing in the stock market comes with many risks that can be managed with proper portfolio construction and a long time horizon. History shows that despite the ups and downs of the market, being invested in quality companies is still the best way to grow wealth and achieve financial goals over time.
Stocks never move up in a straight line, so how we react to market volatility is perhaps more important than the volatility itself.
The S&P 500 has now experienced its second 5% or worse pullback this year. This is below the average of 4 to 5 pullbacks experienced in the average year.
The bottom line:
- Investors should remain level-headed,
- Stay focused on long-term goals amidst these fluctuations, and in fact,
- Take advantage of possible opportunities to purchase when the market is down, i.e., buy good companies when they are “on sale.”
-Paul R. Rossi, CFA