Three things you should know
1. It's been a bad month: Despite recovering their losses from earlier in the week, stocks are still on course for their worst monthly performance in more than three years. The S&P 500 is down about 5.7 percent in August, and the Dow is down 6.1 percent.
2. Great Recession flashback? Investors pulled $17.8 billion out of stock funds by end of day Wednesday after a plunge in stock markets spurred a flight to funds that hold safer assets.
3. When will it happen again? The U.S. stock market entered into its last correction in October 2011. Historically, market corrections have occurred every 18 months.
Last week’s wild ride in the world’s stock markets left whipsawed investors wondering what lessons they could glean from one of the most turbulent periods in equity market history.
But several market analysts say those lessons will remain elusive, in part because the recent sell-off on Wall Street underscores the disconnect between fluctuations in the equities market and economic growth.
“It is important to understand that the economy is not the same as the stock market,” said Ken Mayland, founder of ClearView Economics, a suburban Cleveland-based economic research and forecasting firm. “Clearly, our U.S. stock market is being affected sympathetically by foreign influences. A while ago it was Greece. Now it is China. But events there have very little direct impact on our economy.”
Stocks fell heavily in the first two days of trading this week on concerns about the health of China’s economy. After a rough close in the final days of the previous week, on Monday, within minutes after the opening bell, the Dow plummeted 1,089 points — the largest point loss ever during a trading day. The Dow rebounded enough to close the day down 588 points, its worst decline since August 2011.
Tuesday’s session started out promising, with the Dow bouncing up 442 points at one point, but the final hours brought a significant sell-off, and the Dow closed down another 205 points.
Wednesday finally brought relief in the form of a 619-point Dow gain, its largest point jump since the 2008 financial crisis. And a 369-point gain on Thursday brought the best two-day point rally in the Dow’s history. The markets returned to a comparatively sedate day of trading on Friday, with the Dow falling a scant 13 points.
Despite recovering their losses from earlier in the week, stocks are still on course for their worst monthly performance in more than three years. The S&P 500 is down about 5.7 percent in August, and the Dow is down 6.1 percent.
Markets have been volatile since China decided to weaken its currency earlier this month, a move that investors interpreted as an attempt to bolster a sagging economy. Traders are also jittery about the outlook for interest rates. The Federal Reserve has signaled it could raise its key interest rate for the first time in nearly a decade later this year.
William Wood — a certified financial planner with the Centerville firm of Adams Wealth Management Group and director of the financial-services program at the Raj Soin College of Business at Wright State University — said China’s problems “provided a convenient excuse for a much-needed pullback in the market.
“Our economy hasn’t changed and isn’t directly affected by a slowdown in the Chinese economy,” Wood said. “The Chinese economy has been slowing and showing signs of further slowing for months.”
The Chinese government’s decision to devalue the country’s currency raises the cost of imported goods, but because China is not a major market for the vast majority of southwest Ohio firms, local businesses “should not see any material impact” from the uncertainty in China, Wood said.
Mayland said he believes stock market volatility over the past two weeks was the result of panicked selling by investors caught up in negative headlines from overseas, rather than a reflection of the intrinsic value of the companies represented in the major U.S. stock indices or the performance of the economy as a whole.
“Panic is a good description; another word is irrationality,” Mayland said. “You can find several Ohio companies whose share prices have fallen 15 percent of more just over the past two months. Do you mean to tell me that all their future profit prospects have declined 15 percent in just two months? Is the economic outlook that much different? Hardly.”
The market downturn is difficult to justify in light of the bulk of recent economic reports that show the domestic economy gaining momentum.
On Wednesday, the government reported the U.S. economy grew at a much faster pace than initially thought, expanding 3.7 percent over the past three months — the fastest pace since 2007. While the latest GDP numbers reflect the period before concerns about China peaked, they also reflect long-term trends that have been adding to growth for the past several years, especially housing and employment data.
In the Dayton area, for example, home sales hit an all-time high in June before leveling off slightly last month, reflecting the national trend. Meanwhile, jobless claims fell to an all-time low in July, which marked the 58th consecutive month of U.S. job gains as labor market fundamentals continue to improve.
Mayland compared recent market volatility to the period before and after the “Black Monday” market crash on Oct. 19, 1987, when concerns about a global financial crisis led to the largest one-day market correction in history. The Dow lost 22.6 percent of its value, or $500 billion dollars, as the market was flooded with sell orders in a matter of minutes.
But instead of ushering in a new era of financial Armageddon, the 1987 market crash marked the beginning of one of the longest bull markets in history, extending through the early 2000s before suffering a major pullback later that year tied to the dot-com crash.
“When the stock market crashed in 1987, the economy did not see a quarter of negative growth,” Mayland noted. “Even if you had perfect knowledge of where the economy was going, you would still have a devil of a time forecasting the stock market with any accuracy.”
Tony Caporale, professor of economics at the University of Dayton, said while there has been plenty of analysis about last week’s turbulence and what triggered it, “In truth, no one knows the exact cause of short run movements in stock prices. Their value depends on forecasts about the future growth of the underlying companies. Forecasts can be pretty bad since our experience with crystal balls is that they are often pretty cloudy.”
The lesson for “Main Street” investors, Caparole said, “is that stocks are risky. And by risk I don’t mean volatility, I mean you can lose your shirt.
“Those who don’t have the stomach for risk probably shouldn’t have much in equities. Those who do, and who also have a long time horizon, can think of sharp selloffs as an opportunity to buy good companies at day-after-Christmas sale prices. Those stocks will most likely be a great deal — eventually.”
WSU’s Wood also doesn’t see investors turning their backs on stocks anytime soon.
“Investors are not making money in money market mutual funds or bonds. Where are they making money? Stocks,” Wood said. “Until something competes with stocks on a risk-adjusted basis, investors will continue to pour money into stocks. And to the extent that our economy and market are still world leaders, foreign money will continue to pour in to our markets, driving up U.S. stock prices.”
But the next few months will likely bring more volatility, Wood said, so investors need to guard against panic. “Investment history is replete with examples of investors who sold into down markets and got burned badly,” he said.
Jim Russell, a money manager for Cincinnati investment advisory firm Bahl & Gaynor, also believes there’s more turbulence ahead.
“If you’re thinking crisis averted, there’s probably more hiccups on the way,” Russell said. “(However), don’t confuse the market’s volatility with a pending recession here.”
Rachel Wilson, assistant professor of business at Wittenberg University, also doesn’t see the volatility subsiding for any extended period.
“In the long run, markets will continue to climb, but it’ll just be a bumpier ride,” Wilson said. “The long-term investor just needs to stay true to a prudent investment philosophy and not bail on the speed bumps.”
This story contains material from the Associated Press.
Staff writer Chelsey Levengston contributed to this report.
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