After being on upward movement for months, the stock market hit a giant speed bump on Monday, February 5th, when the Dow Jones industrial average plunged — tumbling more than 1,500 points at one point after sinking 665 points on Friday, February 2nd.
By the close, the Dow had lost around 2,200 points since Jan. 26, closing in on a 10% decline — which would mark the start of an official “correction.”
On paper, Wall Street should be rejoicing right now — not racing to cash out as investors have been doing lately.
Investors, after all, recently got the corporate and income tax cuts they’ve been clamoring for. The economy is accelerating for real, with U.S. gross domestic product now expanding at a annual pace of more than 3% (after inflation) for three straight quarters.
And for the first time in a long while, it appears that worker wages are finally beginning to lift, with average hourly earnings rising to $26.74 in January — a 2.9% increase over the past year.
This represents the fastest rate of wage growth in nearly nine years, since the end of the Great Recession. And it effectively marks the end of the global economy’s war against deflation, which had been the biggest economic threat since the financial crisis began more than a decade ago.
In theory, these are all bullish developments. Yet stocks are going in the opposite direction.
Well, it all depends on the nature of the stock market declines.
Eight of the 12 worst months for stocks were in the midst of recessions. With the exception of the tech bubble bursting in March 2001, the recession-related stock market declines happened well after the economy was in the dumps, so the market correction itself was reflecting diminished growth expectations.
In those recessionary periods, hundreds of thousands of jobs were lost before and after the bad months for stocks. Unemployment worsened in all cases; consumer confidence declined in all but one. And as a result of poor economic conditions, the fundamental drivers for housing were weak and home sales also declined.
The remaining four worst months for stocks since 1950 have occurred in times of economic expansion. They were October and November 1987, when the Standard & Poor’s 500 declined 25% collectively; September 2001, after the U.S. terrorist attacks; in August 2011, when the U.S. was locked in political turmoil over the debt ceiling. These declines were market corrections—when valuations declined but the economy itself, and therefore housing fundamentals, were not affected, which is precisely what’s happening right now with our strong economy and the recent stock market drop.
In those cases, hundreds of thousands of jobs were created in the three months following the correction. Unemployment declined or remained flat. Consumer confidence rose in subsequent months in half of the cases, and in others consumer confidence declined. Home prices were not affected negatively.
But, in some cases the pace of home sales declined for a few months following the market corrections, probably because the decline in stock assets cut into some buyers’ funding. In 2015, 21% of buyers used the proceeds of a stock or bond sale or funds or loan against a 401(k) or IRA, according to the National Association of Realtors® Profile of Home Buyers and Sellers.
Therefore we can assume that a portion of today’s buyers—potentially 20%—could postpone or delay a purchase decision in the next few months as a result of the recent stock declines.
We’re not yet seeing an immediate impact on aggregated traffic and activity on realtor.com® that would indicate a shift in interest as a result of the stock market declines. It will take a few more days and weeks to see if a discernible pattern emerges that is distinct from the normal seasonal trend.
If demand does indeed decline from those affected by the loss in stock values, it might just be what the struggling would-be buyer needs to gain the upper hand in a market that so far this year has clearly favored sellers.
Even though inflation seems tame right now — the consumer price index is up a modest 2.1% over the past 12 months — there’s a good chance inflation could start to pick up steam.
Why? For starters, “signs indicate that wage growth is headed even higher later this year,” says Brad McMillan, chief investment officer for Commonwealth Financial Network
For example, the labor force participation rate — which measures the percentage of the working-age population that is employed or looking for work — “seems to have hit an upper bound at around 63% and has been bouncing around somewhat below that,” McMillan notes. Even with wages and job creation accelerating, January’s labor participation rate was 62.7%, which is about where it’s been for four straight months.
“This could be a sign that all of the workers available, or close to it, are now working,” he says. And if that’s the case, companies seeking to employ new workers may have to shell out even higher wages to attract talent, potentially pushing inflation up even higher.
That, in turn, could mean that corporate profit margins are about to be pinched.
It’s not just the threat of rising inflation that investors fear. Wall Street is also worried about what the Federal Reserve might do in response.
“The catalyst isn’t fear of a growth slowdown; it is fear of too much growth and surging bond yields,” says Jeffrey Kleintop, chief global investment strategist for Charles Schwab. “An overheating global economy could mean a more rapid shift by central banks to rein in stimulus” — typically by raising interest rates rapidly.
And rapid rate hikes in an overheating economy is “often a precursor to a recession and a bear market,” he notes.
It’s hard to blame any of this on new Federal Reserve chair Jerome Powell. After all, he was just sworn in as chairman of the U.S. central bank on Monday afternoon. And the sell-off began well in advance.
However, the markets have historically had a knack for testing new Fed chairman at critical junctures of the economy.
Investors will recall that Alan Greenspan became Fed chairman in August 1987, as the central bank was already hiking rates toward the end of a long economic expansion. That transition took place just weeks before the October 1987 market crash, in which stocks lost nearly a quarter of their value on a single day.
Ben Bernanke similarly assumed the Fed chairmanship in 2006, at the end of another cycle in which housing and stock prices were greatly inflated. About a year later, the stock market entered into a bear market in which equities lost more than half their value.
Powell will preside over his first Federal Open Market Committee meeting in March, at which point investors will be parsing his every word to see if he plans to be any more aggressive in raising rates than his predecessor Janet Yellen. Odds are, he’ll try to stress continuity and plan to raise rates only gradually.
“He certainly would rather not start off with a calamity like the one Fed Chairman Alan Greenspan had to deal with just two months after he started his new job on August 11, 1987,” noted Ed Yardeni, president and chief investment strategist for Yardeni Research, in a recent note to investors.
First off, don’t panic. Market corrections of 10% or more are frequent occurrences, and the vast majority of stock corrections don’t turn into full-fledged bear markets, defined as losses of 20% or more.
In other words, this is not the time to undo your entire investment strategy, but it might be time to start diversifying your portfolio more.
Recently, private money lending has become a new option for those who are unhappy with the volatility of the stocks. Most real estate investors put private lenders as their 1st or 2nd lien holder on the mortgage, insuring the investor’s returns if the market were to come crashing down or the investor made drastic mistakes with their project.
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