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Worst Drop in Wall Street So Far This Year: What Happened?

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Something of a “perfect storm” hit the markets yesterday, leading to all sectors in the US markets taking a dive. The Dow even wiped out all of its gains so far this year. The dollar also notched a gain as traders headed for safe havens. Now the question is whether this was just a short term correction, or has the rally since the start of the year come to an end?

First we need to understand why the market reacted the way it did, which can be a little tricky given some of the contradicting nature of the news. Basically, the market hit a mode where “good news is bad news” because of the Fed; but also “bad news is bad news” because of the economy.

The good news (that’s bad)

US flash PMIs came in well above expectations, with manufacturing jumping back into expansion to pretty much everyone’s surprise. Normally that would be good news, since it came after several other positive indicators, such as better retail sales and stronger hiring. But the markets understood that as an indication that the Fed will keep raising rates for longer, which weighed on the stock market. Particularly the tech sector, which fell almost 3.3% yesterday, was the second worst performer.

Analysts are pointing to the stock market essentially “catching up” to the bond market, as yields on US treasuries have been going up recently with each bit of good economic news. A more resilient economy implies the Fed has more room to keep hiking. And there is already talk of a 50bps hike at the next meeting, meaning that rates could go up a lot farther than the stock market has been expecting so far. Though, what’s bad for the stock market is typically good for the currency, so the dollar got stronger through the turmoil.

The bad news (that’s bad)

Before the opening, two major US retailers reported disappointing results. Both Walmart and Home Depot suggested that there was considerable uncertainty about consumer resilience. Home Depot in particular was impacted as investors were worried about the housing market. The National Association of Realtors reported that house sales had dropped to the lowest level since 2012, and the rate of house price growth has halved.

The worry is that higher rates are pinching US consumers. The economy has remained resilient, giving the Fed more room to hike, which in turn could weigh on consumers later in the year, threatening a recession. The consumer discretionary segment was the worst performer yesterday, essentially dragging down the market.

Putting it together

The impact on the market appears to be a one-two punch of issues for the short term combined with issues for the long term. What the Fed is expected to do weighs on short-term risk sentiment. But the forecasts about consumer behavior for the rest of the year weighs on the medium to long term.

The FOMC minutes might help resolve some of the short-term doubts, and support the market. Or if the interpretation is that the Fed will hike by 50bps as an increasing number of economists suspect, it could be another push towards a move lower, as traders worry more about a recession.

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