As you may have read, the stock market had a difficult day today, with the S&P 500 and the Dow both down more than 3%. Many individual stocks, especially Technology stocks, fared worse: Google was down 5%, Amazon was down 6%, and Netflix was down 8%. For reference, the market’s typical daily movements are 1% or less. Below are some thoughts and recommendations.
What caused this? The overall issue in recent months has been interest rates. The Federal Reserve has increased rates three times already this year and has indicated that it plans another increase before year-end. The most recent increase was on September 26, and that seems to have triggered the market selloff.
Why do stocks go down when interest rates go up? While there is not an ironclad relationship, in general rising interest rates negatively impact stocks in several ways. Among them: Higher interest rates make it more expensive for companies to borrow, thus reducing their profits. Higher rates also make it less likely for big companies to borrow for the purpose of buying back their own stock, which can be a big driver of stock prices. And, when it is more expensive to borrow, big companies will buy less from other companies. Finally, higher interest rates make it more expensive for consumers to borrow — for home mortgages, for auto loans and for everyday purposes on credit cards. Since consumers account for the bulk of economic activity in this country, this also impacts the revenue and profits of public companies.
Is this a sign that the economy is getting worse? No. In fact, it is a sign that the economy is very healthy. Growth has been strong, and unemployment is very low. That is specifically why the Fed has been raising rates — to ensure that a strong economy with near-record-low unemployment (which allows workers to bargain for higher wages) does not cause inflation to rise too quickly.
Will this get worse? Does this warrant a change in investment strategy? If your asset allocation is in order, you should be able to weather a downturn in the stock market, even a multi-year downturn. That said, the headlines can be unnerving, and it always valuable to take opportunities like this to revisit both your financial capacity for risk and your emotional tolerance for risk.