What does the fall in the stock market tell us?
After staging a rally on Monday, when the Dow Jones Industrial Average rose 2%, the stock market stalled on Tuesday. By the close of trading, the Dow had made a small gain, but the broader S. & P. 500 index was down nearly 1% and the Nasdaq composite more than 2%.
If the Dow Jones falls again this week, it will be the ninth week in a row: the longest streak since before World War II. The media is full of stories about a bear market, which is usually defined as a drop of twenty percent or more, but what is happening needs to be put into perspective. Outside of the cryptocurrency sector, where there has been real carnage, this year’s fall in stocks has only partially erased the windfall investors enjoyed in the first two years of the pandemic, when Wall Street was buoyed by rock-bottom interest rates and a gush 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 start of the pandemic, the S. & P. 500, which includes most of the nation’s largest companies, 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 about seventeen percent, above that pre-pandemic peak. The performance of the Nasdaq composite was very similar. On Monday, the tech index closed at 11,535.27, which is also about 17% above its pre-pandemic peak of 9,817.18, which came on February 19, 2020.
To put it a little differently, in a twenty-seven month period in which the economy has been under virtually unprecedented stress – prolonged shutdowns, widespread supply chain problems and, more recently , a global energy price shock – the stock market , overall, fared quite well. Even after the recent market slump, investors who kept their savings in an index fund or maintained a well-diversified portfolio of individual stocks are sitting on substantial gains compared to the pre-coronavirus era. You might not pick up this message from CNBC or social media, but the numbers don’t lie.
Of course, this year’s drop has been shocking, especially for investors who have been stocking up on home favorites such as Netflix, Zoom and Peloton, which are now trading well, well below their pandemic peaks. But for most people, especially the nearly half of American adults who own no stocks, either through individual holdings or index funds, the key question is whether the market crash is simply correcting past excesses or signals something darker: a recession in which GDP contracts and unemployment rises dramatically.
When approaching this question, it is good to remember that a fall in the Nasdaq or the S. & P. 500 does not necessarily mean that the economy is doomed. The drivers of economic growth are spending and hiring, both of which have held up quite well despite a dramatic surge in inflation that has driven down real wages. Last month, retail sales posted a solid 0.9% increase, translating to an 8.2% year-over-year increase. And so far in 2022, employers have created more than half a million jobs each month, on average.
Naturally, the Biden administration is touting these numbers. “The United States economy is resilient,” Cecilia Rouse, chair of the White House Council of Economic Advisers, said during an online panel last week. Rouse argued that three factors are driving the economy: a buoyant labor market, in which unemployment insurance claims are at their lowest level in more than fifty years; strong levels of US business investment; and healthy household finances, which reflect the assistance provided in last year’s American Rescue Act. (Previous pandemic programs that Congress passed under the Trump administration also helped.) “Most household balance sheets are strong and can provide a cushion for rising prices,” Rouse said. “I understand that rising prices are painful. I understand that. But thanks to last year’s efforts, there is a cushion to adapt and respond to.
Rouse was making a point that many economists recognize but that political debate largely ignores. Thanks to unprecedented levels of government support in the first two years of the pandemic, including through stimulus payments and the enhanced child tax credit, many American households have paid off some of their debts, especially the balance their credit cards, 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, overall credit card balances fell by forty-nine billion dollars, the second steepest decline ever recorded. At the end of the first quarter of this year, total credit card balances were $86 billion lower than they were at the end of 2019.
On Monday, JPMorgan Chase, the nation’s largest bank, said it saw little sign of an increase in loan delinquencies, which often accompany a weakening economy. “Overall, the near-term credit outlook, particularly for the U.S. consumer, remains strong,” said Jeremy Barnum, the bank’s chief financial officer. That’s the good news. The bad news is that most pandemic relief programs have now expired and credit card debt is rising again, as are car loans and student debt. And, at the same time, consumer prices and interest rates are also rising sharply. (While the vast majority of borrowers are keeping their payments, auto loan delinquencies are rising, especially among borrowers with low credit scores.)
What will happen to household finances, consumer spending and hiring as Fed Chairman Jay Powell and his colleagues hike interest rates to slow the economy and lower inflation ? This is the fundamental economic question of this year. Last week, Powell reiterated that the Fed would continue to tighten monetary policy until it sees “clear and convincing” evidence that inflation is falling toward the central bank’s 2% target. While Powell expressed hope that the Fed could achieve a “soft or soft landing” for the economy, he also acknowledged that achieving such an outcome “will not be easy.”
A few months ago, economists hoped that inflation would fall sharply in the second half of this year, but Russia’s invasion of Ukraine sent energy prices skyrocketing, and further shutdowns of coronavirus in China have created more problems in the supply chain. Last week, the national average gas price per gallon topped $4.50 for the first time, AAA reported, and Chase predicts it could surpass $6 a gallon by August. Although overall retail sales have remained strong, signs of weakness are emerging in some sectors of the economy, notably the housing market, where mortgage rates have risen sharply this year; and even in parts of retail, where Target and Walmart have reported inflation-conscious consumers are turning to essentials and cheaper private label.