Traders want to know: Why is the stock market down today? The Dow Jones Industrial Average fell 286 points on Thursday, making for a 1.1% loss. The S&P 500 index dropped 34 points for a similar percentage loss. Meanwhile, the tech-heavy Nasdaq Composite index was hit harder, falling more than 1.5%. This was hardly the first day of selling either.
In recent weeks, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) has lost nearly 5%. The Nasdaq 100 index, as tracked by the PowerShares QQQ Trust (NASDAQ:QQQ) has fallen 7% from recent highs. So what’s going on, why is the stock market down so much?
To be clear, these losses aren’t nearly as bad of a drop as we saw last December, at least so far. But investors are right to be feeling cautious at this point. The December decline was cause primarily by an overeager Federal Reserve. The Fed was dead-set on raising interest rates, despite a softening economic outlook.
It took a steep drop in stocks, plus some haranguing from President Trump, for the Fed to back down. As we saw Wednesday, however, the Fed is clearly on the sidelines now, and is no longer threatening to keep raising rates. Even with the Fed neutralized as a potential stock market obstacle, however, the market is still dropping.
Trade War’s Getting Real
The most obvious losers in the stock market recently have been companies exposed to trade with China. Over the past two weeks, we’ve gone from cautious optimism about an imminent trade deal to the two sides seeming to be worlds apart. While the rhetoric ebbs and flows through the course of the day, it seems clear that this is going to be a lot more complicated and time-consuming to resolve than, say, the new Canada/U.S./Mexico trade pact that the three countries agreed to last year.
Until this month, however, the effect of the escalating U.S.-China tariffs had been limited. A few companies, such as industrials, were taking a hit as orders dried up. In general, however, the trade war has had a modest — at worst — impact on the U.S. economy. GDP growth is strong, unemployment is low, and consumer confidence remains elevated. This shouldn’t be shocking. China makes up just 10% of U.S. exports right now. Mexico, Canada, and the European Union buy far more from America each year than China does.
Now, however, things are changing. Washington has taken a more confrontational stance toward Beijing, particularly in regards to technology. In particular, the U.S. is threatening Huawei. The U.S. blocked Huawei from working with American firms before giving them a temporary exemption. Alphabet (NASDAQ:GOOGL) followed up on this by blocking Huawei from accessing future Android updates.
Not surprisingly, China has responded with threats to American tech companies including stopping exports of key rare earth minerals necessary for many modern technological gadgets. Semiconductor stocks have gotten pounded in particular, along with the QQQ ETF in general, as investors contemplate the risk of an extended trade spat that screws up supply chains on both sides of the Pacific.
Oil Takes a Hit
It’s easy to blame everything on the trade war. And to be clear, the trade war is the primary cause of the current stock market drop. But the effects are branching out well past China and the U.S. directly. For one, look at crude oil.
The price of NYMEX crude oil fell more than 5% on Thursday to just $58 per barrel. That’s down sharply from $66 a barrel just a few weeks ago. The price of oil often reflects global economic sentiment, so a trade war would be negative anyway.
But this drop appears to be more specific. China announced Thursday that it would build closer ties with Iran in part to respond to American aggression. Presumably, that cooperation would involve buying Iranian oil. Iran has had issues selling its crude due to sanctions. Thus the price of oil sank, as China took a step that will both punish the West and raise already simmering tensions between Iran and the U.S. Lower oil prices, for what it’s worth, put a great deal of pressure on the already embattled American E&P industry.
Interest Rates See Collateral Damage
Oil wasn’t the only non-equity casualty of Thursday’s frenzied trading. Interest rates also slumped, with the benchmark 10-year Treasury yield skidding to 18-month lows. Following President Trump’s election, interest rates shot up as investors anticipated faster economic growth and higher inflation. Since this past October, however, this dream has fizzled. Now investors are hunkering down for less economic growth and minimal inflation.
Generally falling interest rates are associated with a weakening economy. If you believe what the bond market is saying, the outlook for U.S. stocks and the economy is fading, regardless of what happens with the trade war. Investors are piling into defensive stocks like REITs and power utilities while dumping just about everything else. It’s hard to spin that as bullish for stocks.
This Could All Reverse On A Dime
Why is the stock market down so much? While there are various factors, the trade war is the central theme that ties them altogether. As such, the situation looks fairly negative now as there is no sign of things getting better between China and the U.S. imminently. But if we’ve seen anything with the Trump administration, it’s unpredictability. One moment, it’s all fire and fury, and then the next moment, Trump is shaking hands and waving for the camera.
There’s no basis to forecast that a trade deal is still coming anytime soon. But with this administration, it’s always best to prepare for the unexpected. As it is, the U.S. economy remains strong, unemployment is low, and consumers are enjoying wage increases … spending them fairly quickly. The fundamentals are sound. Thus, as unpleasant as all this trade war news is, it makes sense to hold onto your stocks despite the negative sentiment.
The odds favor the stock market being able to shake off this disruption and resume its rally later this summer. I am forecasting the S&P 500 to top 3,000, which corresponds to SPY topping $300 over the next six months, for a 7%-plus gain from yesterday’s $280.31 close.
At the time of this writing, the author had no position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
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