What Is the Fall in the Stock Market Telling Us?

After staging a rally on Monday, when the Dow Jones Industrial Average rose two per cent, the stock market stalled on Tuesday. At the close of trading, the Dow had eked out a small gain, but the broader S. & P. 500 index was down nearly one per cent, and the Nasdaq composite was down more than two per cent.

If the Dow falls again this week, it will be the ninth week in a row: the longest streak since before the Second World War. The news media is full of stories about a bear market, which is usually defined as a fall of twenty per cent or more, but what is happening needs to be put into perspective. Outside of the cryptocurrency sector, where there has been genuine carnage, this year’s tumble in stocks has only partially erased the bonanza that investors enjoyed during the first two years of the pandemic, when Wall Street was buoyed by rock-bottom interest rates and a gusher of freshly minted money from the Federal Reserve. The pandemic bubble may have burst, but stock prices are still at very high levels.

A few numbers tell the story. On February 19, 2020, about a month before the onset of the pandemic, the S. & P. 500, which includes most of the biggest corporations in the country, closed at 3,386.15, an all-time high. On Monday, the index closed at 3,973.75—about five hundred and eighty-seven points, or roughly seventeen per cent, above that pre-pandemic peak. The performance of the Nasdaq composite has been very similar. On Monday, the tech-heavy index closed at 11,535.27, which is also about seventeen per cent above its pre-pandemic peak of 9,817.18, which came on February 19, 2020.

To put it slightly differently, during a period of twenty-seven months in which the economy has been subjected to virtually unprecedented strains—lengthy shutdowns, pervasive supply-chain problems, and, most recently, a global energy-price shock—the stock market, as a whole, has done pretty well. Even after the market’s recent slide, investors who have kept their savings in an index fund or maintained a well-diversified portfolio of individual stocks are sitting on substantial gains relative to the pre-coronavirus period. You might not pick up that message from CNBC or social media, but the numbers don’t lie.

Of course, this year’s fall has been jarring, especially for investors who loaded up on stay-at-home favorites such as Netflix, Zoom, and Peloton, which are now trading far, far below their pandemic peaks. But for most people—especially for the nearly half of American adults who don’t own any stocks at all, through individual holdings or index funds—the key question is whether the market slump is simply correcting past excesses or signalling something darker: an oncoming recession in which G.D.P. contracts and unemployment rises substantially.

In tackling this question, it is good to remember that a fall in the Nasdaq or S. & P. 500 doesn’t necessarily mean the economy is doomed. What drives economic growth is spending and hiring, which have both held up pretty well despite a dramatic surge in inflation that has led to a fall in real wages. Last month, retail sales posted a healthy increase of 0.9 per cent, which translated into a year-on-year rise of 8.2 per cent. And so far in 2022, employers have added more than half a million jobs each month, on average.

Understandably, the Biden Administration touts those numbers. “The United States economy has resilience,” Cecilia Rouse, the chair of the White House Council of Economic Advisers, said in an online panel last week. Rouse argued that three factors are boosting the economy: a buoyant labor market, in which claims for unemployment insurance are at their lowest levels in more than fifty years; solid levels of investment by American businesses; and healthy household finances, which reflect the aid provided in last year’s American Rescue Act. (Earlier pandemic-relief programs that Congress enacted during the Trump Administration helped as well.) “Most household balance sheets are strong and can provide some cushion for rising prices,” Rouse said. “I understand rising prices are painful. I understand that. But because of the efforts over the past year there is some cushion to adjust and respond to them.”

Rouse was making a point that many economists recognize but the political debate largely ignores. Thanks to unprecedented levels of government support during the first two years of the pandemic—most notably from stimulus payments and the enhanced child tax credit—many American households paid down some of their debts, especially credit-card balances, and replenished their bank accounts. Figures from the New York Federal Reserve show that in the first quarter of last year, when the American Rescue Act was passed, over-all credit-card balances fell by forty-nine billion dollars, the second-largest drop on record. At the end of the first quarter of this year, total credit-card balances were eighty-six billion dollars lower than they were at the end of 2019.

On Monday, JPMorgan Chase, the country’s biggest bank, said it saw little sign of an increase in loan delinquencies, which often accompany a weakening economy. “Big picture, the near-term credit outlook, especially for the U.S. consumer, remains strong,” Jeremy Barnum, the bank’s chief financial officer, said. That’s the good news. The bad news is that most of the pandemic-relief programs have now expired, and credit-card debt is rising again—as are auto loans and student debt. And, at the same time, consumer prices and interest rates are rising sharply as well. (While the vast majority of borrowers are keeping up on their payments, auto-loan delinquencies are picking up, particularly among borrowers with low credit scores.)

What will happen to household finances, consumer spending, and hiring as Fed Chair Jay Powell and his colleagues raise interest rates to slow the economy and bring down inflation? That is the fundamental economic question this year. Last week, Powell reaffirmed that the Fed will keep tightening monetary policy until it sees “clear and convincing” evidence that inflation is dropping toward the central bank’s target of two per cent. While Powell has expressed hope that the Fed can achieve a “soft or softish landing” for the economy, he has also acknowledged that achieving such an outcome “won’t be easy.”

A few months ago, economists were hopeful that inflation would decline sharply in the second half of this year, but Russia’s invasion of Ukraine has sent energy prices soaring, and the new coronavirus lockdowns in China have created more snarls in the supply chain. Last week, the national average gas price per gallon rose above $4.50 for the first time, AAA reported, and Chase is predicting it could surpass six dollars a gallon by August. Although over-all retail sales have remained strong, signs of weakness are emerging in some parts of the economy, including the housing market, where mortgage rates have risen sharply this year; and even in parts of the retail trade, where Target and Walmart have reported that inflation-wary consumers are gravitating to essential goods and cheaper, private-label brands.

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