Is the Damage Done?


Over the past week, the stock market has been hit by a hurricane.

Since reaching their all-time highs October 3rd, the Dow Jones Industrial Average gave up nearly 1800 points (or 6.6%) and the S&P 500 lost 200, for a 6.9% decline at Thursday’s close. The Nasdaq Composite index was off 175 points, or 9.6%, from its August 31st peak.

On Friday all three indices rallied nicely into the close as investors picked through the rubble for bargains. Clearly the Dow around 25,000, the S&P near 2,700 and the Nasdaq in shouting distance of 7,000 again were too tempting for bottom fishers to resist.

The selloff began with some remarks by Federal Reserve Chairman Jerome “Jay” Powell suggesting the economy was very strong and the central bank would keep raising short-term rates at a steady clip. It was a restatement of what’s been Fed policy for the past couple of years, but traders professed to be surprised. They sold off the ten-year Treasury note big time, sending its yield soaring to 3.23%, its highest in 7 ½ years.

The sudden jump in yield—it had settled back to 3.14% Friday—led to a mini-panic among investors who dumped both stock and bond ETFs. The Nasdaq lost almost enough to be in official correction territory (down 10%), while the Dow and S&P are well on their way.

So, is the worst over?

Who knows? You can never predict what markets are going to do, but we can look back to February when something similar happened. Ten-year rates had shot up amid misplaced fears of inflation, the Fed was on a path to hike short rates, and we were in the early stages of a trade war. The S&P just barely had its first correction in years, falling 10.2% from its January all-time high.

We’re most likely seeing a repeat of that. Earnings season starts next week, and the expected strong 20%-plus gains for the third consecutive quarters should distract investors for a while. Then come the midterm elections, where Wall Street’s expectations that Democrats will take the House of Representatives while Republicans keep the Senate looks likely to come true. That would mean a lot of noise and investigations of the Trump administration but continued confirmation of conservative judges and legislative gridlock.

So far, the trade war with China has had little impact on the U.S.—except to increase our trade deficit with them. If that continues to be a chronic issue rather than a sudden crisis, businesses and investors will adapt to it. That could determine whether this is yet another correction—or becomes something worse.