Is the bear back?
Not exactly, but this week could be a harbinger of things to come as the stock market took a literal nosedive both Wednesday and Thursday.
The Dow Jones fell 832 points Wednesday and followed that up with another 469-point drop — just one week after notching a record high.
An article Thursday in USA Today gave a few reasons why the market is suddenly falling off a cliff:
What Sparked the Fall?
A recent spike in the yield on 10-year Treasury bonds is the main catalyst for jitters on Wall Street.
The 10-year Treasury note – whose key rate impacts the pricing on things ranging from fixed-rate mortgages to stocks to virtually every financial asset on the planet – recently climbed above 3.25 percent for the first time since May 2011. And when you add the threat of higher borrowing costs on things such as houses and cars and corporate debt to the economic obstacles caused by the U.S. trade war with China, all it takes is a whiff of weakness to set a major sell-off in motion.
“We don’t know who is to blame here; it’s a little like trying to find what or who is responsible for the dangerous hurricane in Florida today,” says Chris Rupkey, chief financial economist at MUFG, a Tokyo-based global bank with offices in New York. “But make no mistake about it, the stock market decline, triggered perhaps by rising bond yields, is just as dangerous.”
Why are Interest Rates Rising?
Rates are essentially going higher because the economy has been on a record bull market run over the past decade with rates near zero. The Trump administration’s tax cuts also helped throw some fuel on the fire but that’s is starting to wear off.
“Interest rates are rising because economic data has been positive,” explains Paul Hickey, co-founder at Bespoke Investment Group in New York.
After nearly a decade of historically low interest rates and slow economic growth, the U.S. economy is picking up speed, bolstered by President Donald Trump’s policies, such as tax cuts and less regulation of businesses. The economy grew 4.2 percent in the second quarter, its fastest pace in four years. And the job market is robust, with the September unemployment rate of 3.7 percent the lowest in nearly 50 years.
In short, there’s no longer a need for borrowing costs to stay at depressed, emergency levels. The fear now is the economy will get too hot and cause both price and wage inflation to spike, which hurts the buying power of consumers and crimps the earnings of employers.
Why Is Higher Interest a Problem?
“Clearly, higher rates are not good for housing or auto sales,” says Ed Yardeni, chief investment strategist at Yardeni Research. And if sales of these big-ticket items slow, so does the broader economy.
“The lure for these stocks is growth in earnings down the road, but when interest rates are higher, the future value of those earnings streams declines,” Hickey says. On Wednesday, video streamer Netflix fell 8.4 percent, Facebook tumbled 4.1 percent and Apple fell 4.6 percent.
Why are Tech Stocks Dropping?
Tech stocks have also been caught in the trade fight with China, as Trump’s tough stance on Beijing is causing disruptions in their supply chain. Technology companies such as Facebook, Twitter and Alphabet are also facing intense regulatory scrutiny from the U.S. government.
“Tech companies are in harm’s way because of the trade war with China, in addition to concerns about rising interest rates,” says Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.
Is This the Beginning of a Market Correction?
This sell-off could be a decline of 10 percent or more from September’s peak. Zaccarelli is predicting the downturn won’t become a bear market, and will actually turn into a good opportunity for investors willing to ride out the storm.
“The economic fundamentals are strong and rates are going up for a good reason,” Zaccarelli says.
Is There Reason to Panic?
“Sure, investors feel nervous, but this is not the time to panic and sell,” advises Thorne Perkin, president of Papamarkou Wellner Asset Management in New York. “We don’t view this as a psychological shift but an overdue sell-off.”
The current market decline “won’t be fun,” Perkin adds, “but this sell-off will end and a strong economy will carry us through the end of the year.”