Americans used to seeing their retirement accounts and other investments zoom ever higher suffered a reckoning this week, as markets endured their worst week since the start of the coronavirus pandemic.
In an orderly but persistent plunge, nearly all sectors of the stock market sold off. The Dow Jones industrial average lost nearly 1,400 points, or 3.9%, on the week, while the broad-based S&P 500 fell 5.1% since Tuesday.
Technology companies from Apple to Netflix were hit hardest, and the tech heavy Nasdaq index fell 6.2% on the week. Speculative bets on cryptocurrency got hammered.
The biggest drive of the plunge was growing concerns that persistently high inflation will force the Federal Reserve, the U.S. central bank, to aggressively raise interest rates this year. Sharply rising prices on things from used cars to meat to gas has quickly become a dominant concern among Americans. Higher interest rates can cool price increases but also limit economic activity, which often hit stocks, particularly highflying companies, hard.
The decline was a wake-up call for investors, who had seen prices collapse when the pandemic started in March 2020. But markets quickly rebounded, defying expectations on an upward march for the past two years. While nobody knows the trajectory of the stock market, many analysts say the recent sell-off presages a rocky year.
“The market is significantly overvalued, which works okay when interest rates are at record lows,” said Mark Zandi, chief economist at Moody’s Analytics. “But when rates rise, valuations become a real issue, so the market is adjusting to the new interest rate reality.”
Some analysts said the sell-off was an inevitable response to months of rapid growth. But, they pointed out, the economic recovery remains strong, with low unemployment and rising wages.
“This is a normal correction in a bull market,” said Ivan Feinseth, an analyst at Tigress Financial. “Hopefully we are reaching a point of such extreme pessimism, disdain and even fear that we are reaching a bottom soon. The underlying fundamentals are still strong.”
Still, a tough stock market could add to a litany of economic pains Americans have experienced recently, despite the strong overall economy. Supply-chain struggles continue to mean delays of many goods and empty shelves, labor shortages are afflicting numerous industries, and inflation is a top-ranked concern for many Americans in polls.
It also represents a threat to President Joe Biden’s political standing, as Republicans blame his policies for overheating the economy and exacerbating the issue.
As the stock market fell, bond yields also rose, in anticipation of the Fed’s interest-rate increases. That, in turn, threatens to lead to higher costs for a variety of types of borrowing. Most notably, mortgage rates are zooming higher, suggesting that historically pricey housing will only get more expensive for buyers.
Investors are preparing for the Fed to wean the markets off supports offered earlier in the pandemic. Experts are projecting three to five interest rate increases in the coming months. The hope is that by slowing lending, Americans’ seemingly insatiable demand for goods and services will ease, and price growth will cool.
It remains a tricky balance for the Fed, led by Chair Jerome Powell, who Biden has nominated for a second term. Powell wants to slow the economy just enough to get inflation down from 40-year highs of roughly 7% year-over-year price growth to a more healthy 2 to 3%.
If the Fed is too aggressive, it could send the economy crashing into recession and cause unemployment to soar and economic misery to spread. But if it’s too nonchalant about the threat, higher inflation could become an enduring feature of the economy, eating away at wage gains and depressing quality of life.
“Just how successfully the Fed navigates these crosscurrents is the wild card in the outlook,” Bob Schwartz, an economist at Oxford Economics, wrote in a note late Friday.
Domestic markets during the pandemic have seen troubling dynamics before, but have largely looked past them as the Fed kept interest rates low and consumer spending remained robust.
But with covid-19 infections due to the omicron variant surging and a tight labor market, traders this week appeared to adjust their long-term vision of the financial landscape.
The fallout of the week’s losses could have broad consequences, striking 401(k) and retirement accounts and causing borrowers to peel back expectations for the year after a prodigious rise in the market over the past year. The Dow gained 18.7% in 2021, and the S&P did even better at 26.9%.
American consumers, bolstered by a booming stock market and high savings rates, have so far continued to spend despite rising prices and disruptions from the fast-spreading omicron variant. But analysts say they fear sustained drops in the stock market could lead to a broader pullback in spending that would further hamper the recovery.
Bitcoin, the largest cryptocurrency, lost 10% of its value on Friday as it fell to less than $37,000, its lowest level since August. The cryptocurrency is down about 40% from all-time highs near $69,000 in November.