The bullish growth in the stock market has now come into question. The Dow Jones Industrial Average plunged 666 points, roughly 2.5%, marking it the worst day since the Brexit turmoil (June 2016) on Friday. Market trends have been extremely bullish since November 2016 thanks to optimism surrounding President Trump’s expansionary fiscal policy and record breaking corporate earnings. Since the 2016 election the major indexes have hit historical new highs: the Dow Jones has seen roughly 40% increase; the S&P 500 Index has seen roughly 30% increase; and the Nasdaq has seen almost a 40% increase. Investor confidence and optimism surrounding the stock market has climbed as well—stimulating economic growth and suggesting the recovery from the Great Recession is over. However, after having one of its worst days in 2 years, analysts beckoned this sell-off is not over. The Dow plummeted almost 1200 points on Monday trading, including further sell-offs in the S&P and the Nasdaq. There have been talks of a 5% correction, but there has also been talks of a 10% correction. Furthermore, the Dow dropped another 1000 points on Thursday, erasing the some of the recovery from Monday’s turmoil. There is speculation among investors that the correction has started to bottom out, but investors are being patient and assessing market conditions. The amount in which the market corrected was not out of the ordinary, but the speed in which it did is rather unprecedented.
There is one major factor that is triggering this bearish trend in recent days: inflation. Inflation is price change in an economy and is stimulated when the economy is experiencing growth. In the simplest terms, as an economy expands, consumption and investments will increase, and demand for products and services will increase. Businesses and firms will react to higher demand by raising their prices, thus increasing price change or inflation. Last week, the Federal Market Open Committee (FOMC) of the Federal Reserve met for their January 2018 meeting regarding monetary policy. The Federal Reserve meet roughly every 42 days to discuss economic growth and to use monetary policy to raise or lower the target range of the federal funds rate or interest rates. When interest rates increase, it makes consumption and borrowing costly (mortgage and loan rates increase) and, consequently, causes stock prices to fall. The Fed announced that it will keep its bench mark for the federal funds rate at its current level, but its outlook for 2018 was more hawkish than expected, suggesting more frequent or steeper rate hikes. The Fed’s announcement triggered a sell-off in stocks and for Treasury bond yields to increase. Stocks are viewed as higher risk investments, and bonds, especially Treasury bonds that are government-backed, are regarded as safer investments. Attractive yields on a safer investment have made stocks less appealing and bonds more attractive. Furthermore, US wage reports have indicated that hourly wage grew at the fastest rate since the recession ended. Some of the best wage gains from last year came from some of the highest-and lowest-paid industries. The US economy also added 200,000 new jobs in January, a better-than-expected figure, and unemployment rates are at its lowest level in over a decade. Though this report produced great results and inflation has remained mysteriously below the target inflation rate set by the Fed (2%), this triggered a further sell-off in the stock market because of furthered concern for inflation.
Whether the sell-off in stocks is over is still a question, but there is an increased attention to inflation and rising rates due to bullish trends in the stock market and the US economy. Investing in stocks and businesses can be a difficult, emotional transaction. It is imperative to review each investment opportunity with scrutiny regardless of consumer confidence and optimism. When evaluating the attractiveness of an investment, it is important to analyze the underlying fundamentals of the business such as its financials, employees, and management. Moreover, it is important to be aware of exogenous factors—competition within the industry, geopolitical influences, and the general state of the economy.
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