President Joe Biden’s honeymoon with the stock market is over.
After soaring in Biden’s first year in office, markets are off to a dreadful start to 2022. Worries about the Federal Reserve’s plan to fight inflation have driven the S&P 500 down 9% so far this year – all three and a half weeks of it.
The Nasdaq, despite its historic rebound on Monday, finished sharply lower on Tuesday and is on track for its worst month since 2008 and its worst January ever.
It bears reminding ourselves that the stock market is not the economy. The fact that high-flying tech stocks on Wall Street have succumbed to gravity doesn’t change the facts that unemployment is very low, demand for workers is high and wages are rising.
Yet this is not merely a Wall Street problem. Main Street would be threatened by a more serious market downturn, and that would spell political trouble for Biden, whose approval ratings have been hurt by very high inflation.
“The economy and markets are intertwined. A sharp drop in the stock market will impact economic activity. They are all in the same bed together,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
The risk is that the market’s turmoil spills over into the real economy, erasing trillions of dollars in household wealth.
Moreover, further losses on Wall Street threaten to dent already shaky confidence among consumers, who have more exposure to stocks than they used to. If your nest egg just got 20% smaller, do you hold off on booking that vacation? Or buying a new car (assuming you can find one)? Maybe so.
“There is a real threat to Main Street. The Fed is trying to raise rates to ease inflation, but not choke off economic growth. It’s a very fine balance,” said Kristina Hooper, chief global market strategist at Invesco.
At the same time, market stress can make it harder for companies to raise money in capital markets that had been wide-open until very recently.
“A sustained selloff in the stock market starts to catch people’s attention and does affect confidence over time,” said Ethan Harris, head of global economics at Bank of America. “The average person judges the economy by a few statistics. One of them is the Dow Jones Industrial Average.”
Americans are more exposed to market turmoil today
It’s true that the fortunes of the rich are more closely tied to the stock market than the middle class, whose wealth is linked more to home values, which are way up during Covid.
The richest 10% of US households held a staggering 88% of all corporate stock and mutual fund wealth as of the third quarter of last year, according to the Federal Reserve.
Yet stocks represent a greater chunk of the average American’s net worth than they used to.
Households in the 50% to 90% wealth range held $4.3 trillion in stocks and mutual funds as of last year, representing 9.4% of their net worth, according to the Fed. That’s up from just $1.6 trillion and 6.4% a decade ago. In 1991, stocks made up just 4.7% of this group’s wealth.
Likewise, the bottom 50% of US households held $260 billion in stocks and mutual funds, comprising 2.9% of their wealth. That’s up from $90 billion and 1.8% of their wealth a decade ago.
Asked about the recent market drop, a White House official told CNN the administration focuses on trends in the economy, not any single indicator. The official pointed to “real progress” demonstrated by the 3.9% unemployment rate and jobless claims that have declined by about two-thirds from a year ago, when the unemployment rate was 6.4%.
“Unlike his predecessor, President Biden does not look at the stock market as a means by which to judge the economy,” the White House official said, alluding to former President Donald Trump’s well-chronicled obsession with the Dow as the ultimate barometer of economic success.
Economists are on high alert for signs that the stock market stress is infecting the broader capital markets that keep the economy humming.
Yields in the junk bond market have begun to creep higher. A spike would make it more expensive or impractical for leveraged companies to refinance their debt. And that would have a real and immediate economic impact.
Markets have been ‘quite complacent’
The good news is that stocks haven’t yet fallen sharply enough to alarm economists.
The S&P 500 is flirting with a 10% correction from prior highs. Such drops are viewed as healthy after sharp rallies.
“What would make us nervous would be a 15% to 20% drop in markets that is sustained,” said Bank of America’s Harris.
The S&P 500 is nowhere near the 20% threshold required to be considered a bear market, although the Nasdaq got close to that on Monday before rebounding.
“We’ve got a long way to go. I don’t think it’s impossible though,” said Harris. “Clearly, the markets have been quite complacent about the Fed. And the Fed has contributed to that by downplaying the risks and describing inflation as transitory.”
The market stress began earlier this month after the minutes from the December Fed meeting revealed officials are stepping up their efforts to fight inflation by removing the easy-money punch bowl that has juiced the stock market.
That did not set well with investors, who have become accustomed to unprecedented support from the Fed. Near-zero rates, combined with massive Fed purchases of bonds, forced investors to bet on risky assets like stocks. Now, the reverse is happening.
“The Fed is in an impossible spot, one that they put themselves in,” said Boockvar. “They are the architects of this relationship. Now they have to deal with the so-called break-up.”
Soaring tensions between Russia and Ukraine have only added to the stress on Wall Street.
Why the Fed isn’t freaking out
Fed officials, gathering for this week’s regularly scheduled policy meeting, are likely not freaking out about the market turmoil. At least not yet.
Mark Zandi, chief economist at Moody’s Analytics, said the market retreat is a feature, not a bug, of the Fed’s shift to inflation-fighting mode.
“So far, I view this as therapeutic,” Zandi told CNN. “The Federal Reserve wants and needs the economy to cool off, otherwise it will blow past full employment and inflation will become a persistent problem.”
Keep in mind that the Fed regularly speeds up and slows down the real economy in large part by influencing financial markets. Lowering rates supports growth by making it easy to borrow and boosting risky assets. And vice versa.
Despite the recent losses, markets remain significantly higher during the Covid era. Even at Monday’s intraday low of 4,222, the S&P 500 was trading 93% above its low in March 2020 when the nation began shutting down.
To be sure, stocks can’t go straight up forever. A recalibration makes sense given the Fed’s shift in its policy.
“The market got ahead of itself. It got overvalued, bordering on frothy,” said Zandi. “As rates rise, bubbles are coming out.” But he added that a 20% to 25% decline in stocks would become more problematic for the real economy.
“That could cause damage that you don’t want to see,” Zandi aded. “It’s tricky because the market can take on a life of its own.”