The stock market has been a stumbling hot mess for most of 2016, and Wednesday was no exception. Shares plummeted early before staging an afternoon rally that erased most, though not all, of their losses, with the S&P 500 eventually settling at lows not seen in almost two years. It was wild. It was woolly. It was not a good day to contemplate your retirement account. And, of course, it’s not just the United States. Around the world, stocks are in a funk. As President Obama might say, the bear is loose.
Markets are always a little bit inscrutable, prone as they are to fear-driven herd behavior, but right now there are a handful of factors that are pretty obviously causing the tumult. Chief among them are problems in China and the collapsing price of oil, as well as the U.S. Federal Reserve’s restless desire to keep raising interest rates. “It’s something of a perfect storm,” Kristina Hooper, U.S. investment strategist for Allianz Global Investors, told me. “You’ve got multiple events occurring around the same time, all of which are contributing to nervousness.”
So what are these events, and why have they sent stocks careening? For simplicity’s sake, let’s run through the issues one by one, starting with a short prelude.
Stocks Got Expensive
The years following the Great Recession were incredibly kind to stocks, as loose monetary policy from central banks, especially the Federal Reserve, drove more money into them. But as share prices went up and up, they started looking pretty expensive by historical standards. Many began to wonder whether markets were due for a correction, and while problems in the global economy helped drive the S&P 500—which tracks most of the largest U.S. companies—down slightly last year, there’s still a pretty pervasive sense that stocks have further room to fall before they get back to their long-term averages.
China Is Slowing Down
But what finally caused investors to sell, sell, sell? First and foremost, problems in China, which has been the most important driver of global growth for years now and is disconcertingly slowing down. This week, the Chinese government announced that its economy expanded by 6.9 percent in 2015, the worst pace in 25 years. This spells trouble for the many developing and emerging countries that keep their own economies afloat by selling commodities like oil, coal, beef, and soy beans to the People's Republic. And given that developing and emerging markets are responsible for more than 70 percent of global growth, their problems darken the outlook for all sorts of industries, and thus, the stock market.
The tricky part with pinning all of our hopes and economic dreams on China is that nobody entirely trusts its official growth statistics. Therefore investors have to look for proxies that might tell them what's really going on in the country. That's why Wall Street panics when the stock market crashes in Shanghai, even if the plunge is really due to an ill-conceived bureaucratic scheme rather than any sort of economic fundamentals. Likewise, it’s part of the reason why markets get nervous when Beijing allows its currency to devalue, since it could be a sign that the government is worried about growth and wants to boost exports by cheapening the yuan. (Some also fret that a falling redback could set off a damaging currency war in Asia, but that’s a whole other complicated issue.) Bottom line, investors are trying desperately to read China’s tea leaves, and at times they may overreact a bit to what they see—or think they see.
The Price of Oil Is Crashing
That brings us to oil. Thanks in part to American fracking and Saudi Arabia’s refusal to cut back on its own pumping, the world is now producing more crude than it needs, and the price of a barrel has crashed to around $28. Intuitively, that doesn’t sound like such a problem. After all, low oil prices are usually associated with stronger economic growth, since they let families spend money on things other than gasoline.
But investors are spooked. Some seem to be treating oil’s price as another sign that growth in China and the rest of the world is weakening.1 Aside from that, energy companies are getting thrashed, which has hurt corporate profits. And scariest of all, many observers now think that cheap crude may be hurting the United States more than helping it. Consumers don’t seem to be spending the cash they're saving at the pump, while oil companies have been forced to shut down rigs and fire workers. The industry's retrenchment, which has already taken a bit out of U.S. GDP and job growth, could get worse if more oil companies find themselves forced into bankruptcy.
The worst-case scenario—which, seriously, is totally speculative—is that regional problems in Texas or Louisiana start to sap the whole economy, making a recession in the oil patch go national.
The Fed Wants to Hike Interest Rates
The Federal Reserve is also contributing to the sense of dread. In December, the central bank finally hiked interest rates up from near zero for the first time since 2008. The increase was tiny, but it signaled that the days of easy money that fueled the post-recession bull market were officially drawing to a close. Some are concerned that if the Fed continues to tighten its monetary policy, it could also slow the economy substantially.
The Fed is also contributing to another source of worry for the markets—the strength of the U.S. dollar. When things go bad in the world economy, investors turn to good old American assets as a safe haven, driving up the value of the dollar. When the Fed raises interest rates, that too attracts more investment to the U.S., driving up the value of the dollar. When the world is on fire and the Fed is hiking interest rates, the value of the dollar is almost sure to rise quite a bit. And indeed, the greenback has appreciated over the past few months. That's a problem for U.S. exports, which are getting more expensive. It's also bad for foreign companies that borrow in dollars and see the cost of their debts rise. And it's helped drive down oil prices, since crude is priced in dollars.
The U.S. Consumer Might Be Wobbling
As if China, oil, and the Fed weren't enough to make markets jittery, U.S. shoppers are looking a tad unwell. Retail sales declined slightly in December, which is a pretty significant danger sign since consumer spending has basically carried the American economy of late. If the holiday-season sales figures are a sign of things to come, we might be in trouble.
So, welcome to the winter of investor discontent. It’s cold and gloomy out there. Bundle up.
1This seems a little misguided since demand for oil has in fact risen. Supply has just risen faster.