After falling over 2% on Friday, the S&P 500 (INX) index plunged more than 4% on Monday, February 5. The Dow Jones Industrial Average (DJI) plummeted a record 1,200 points. The NASDAQ Composite (IXIC) fell nearly 4%, and the small-cap Russell 2000 (RUT) dropped 3.5%. The U.S. stock market correction has also dragged down prices of global equity indices, especially in Asia and Europe. On February 6, the Nikkei 225 (NI225) fell 4.7%, the Shanghai Composite (SHA) fell 3.5%, and the Euro Stoxx 50 (SX5E) fell 2.5%. From its all-time high of 2,872.87 on January 26, the S&P 500 is down over 7.5%. As many investors were surprised by the sudden correction in a historic bull market, they have many questions going forward.
The conventional wisdom is that Friday's jobs report showed excellent wage growth, which sparked fears of higher inflation than expected. Higher inflation usually means the U.S. Federal Reserve will raise interest rates more than expected, and higher interest rates hurt equities by increasing the cost of borrowing. Spooked investors sold off some of their stocks, and Wall Street's high-frequency trading algorithms did the rest, panic selling into the weekend and Monday's close.
Another potential factor is that a new Chair of the Federal Reserve, , President Trump's nominee, began his tenure as the 16th Chairman. Bucking a trend set by prior Fed appointees, Powell does not come from an academic background, instead building a career in law, investment banking, and venture capital. Considered more hawkish than dovish, Powell may raise interest rates more aggressively than his predecessor Janet Yellen. That policy shift could be concerning to long-term investors.
The correction has dragged down other markets because the U.S. economy is such a big and important part of the world. As major trading partners, China, Japan, and Western Europe are also spooked when U.S. equities drop. In addition, the generally uncorrelated cryptocurrency markets also took a hit over the weekend, with Bitcoin dropping over 20% to a new low below $6,000 before bouncing. Finally, the correction killed a popular exchange-traded note (ETN), VelocityShares Daily Inverse VIX Short (NASQAQ: XIV), which lets traders buy a derivative that is the inverse of the Chicago Board Options Exchange VIX volatility index futures. As VIX skyrocketed 100% over the weekend and on Monday, the price of VIX fell 90%. The issuer of XIV, Credit Suisse (NYSE: CS), has elected to liquidate the ETN on February 21. Because shorting VIX is a trillion-dollar trade made by institutional and retail clients alike, the acceleration event and liquidation will negatively affect a few unlucky, risk-pursuing investors.Fundamentally, the U.S. economy is in a good place. Job growth has reached record numbers, and wage growth is finally starting to catch up to the stock market. Bullish equity investors are rightfully exhausted after a historic bull run for almost a decade. The recent downturn is likely just a healthy correction that will give new investors-who should not be shaken-the opportunity to buy in at relatively cheaper prices.
The author holds a long position in the S&P 500 and BTC.