Last week, the stock market officially encroached upon correction territory, which is defined as a reverse movement of at least 10% in some type of security. More specifically, the S&P 500 and Dow Jones indexes each fell by nearly 10% between Wednesday, January 31, and Thursday, February 8, before rebounding on Friday, February 9. The below graph titled A Comparison of the S&P 500 & Dow Jones Indexes shows the two market indexes’ fluctuating declines over the nine-day stretch. But what do fluctuations in the stock market actually mean, and what impacts do they have on the economy and accounts receivable management (ARM) industry? In short, we should simply analyze stock market changes as reflections of investors’ perceptions of future economic growth and improving business conditions, and ARM companies should not be too worried going forward.
As we can see from the above graph, the two primary stock market gauges each fell substantially between January 31 and February 8. Specifically, the S&P 500 declined by 8.6%, and the Dow Jones Industrial Average (DJIA) fell by 8.88% over this time period. At certain points over this eight-day stretch, stock market decline approached the infamous 10% threshold, which would officially deem the decline as a market correction. Following Friday’s rebound, each of these two indexes fell by 7.23% and 7.49%, respectively, over nine days, negating much of 2018’s initial market gains. Many investors and analysts were terrified by a potential crash, but, realistically, this downfall was primarily driven by positive economic growth and a small implicit modification of 2017’s potentially skewed growth.
First off, 2017 experienced significant stock market growth compared to historical averages, so there was bound to be some drop soon thereafter. The stock market generally increases by about 6%-9% annually, depending on which index and which time period you’re analyzing – this is the baseline, or expected annual return. However, 2017 boomed for returns of greater than 20%, with the S&P increasing by 21.83% over the calendar year, and the DJIA growing by 25.08%. As such, a simple reversion back to the average in 2018 should have been anticipated.
Second, the beginning of the sell-off of stocks occurred in proximity to the release of the Bureau of Labor Statistics’ most recent jobs report on February 2. Although there was hardly any negative data found within that release, the strong growth of average hourly earnings of 2.9% year-over-year, following three years of over 2% growth, was thought to be a major contributor to investors’ decisions to sell stocks. But why? If wages are increasing, which is a sign of a booming economy, shouldn’t investors feel more optimistic about continual economic growth? The answer is yes, but investors also considered the fact that if wages are increasing more quickly, then businesses bottom lines won’t be as high. In other words, business profits won’t be as high since firms are paying employees more, on average.
A third reason for the massive sell-off was due to expectations of the Federal Reserve’s (Fed) monetary policy under new Chairman, Jerome Powell, following four federal funds rate increases since December 2016. Basically, former Chairwoman Janet Yellen implemented a cautious but optimistic strategy to the Fed’s monetary policy over her term. She maintained historically low interest rates throughout the majority of her tenure as chairwoman, but as the economy improved and approached full employment over the past two years, she decided to slowly increase the baseline interest rates. As the economy continues improving, the Fed is expected to raise rates at least two or three more times this year, bringing its baseline rate back to a relatively normal historical value. As such, many investors anticipate that businesses won’t be able to borrow money as easily – because it’s more expensive – which will slow down companies’ abilities to grow, potentially negatively impacting bottom lines as well.
So between these three reasons, and the vast amount of data and speculation in the news, the stock market was simply due for a decline. The economy continues expanding and improving, wages are growing, and monetary policy is changing to reflect these positive developments. We should continue viewing the stock market simply as an indicator of investors’ perceptions of the economy, not how well the economy, specifically, is doing. Just because the stock market increases or falls in a short time span, doesn’t necessarily mean the economy is improving or receding. We should be cognizant of the stock market simply as another part of the broader picture when analyzing the economy. If many other prime economic indicators were also worsening, then there’d be a greater cause for concern. But in this one case, there should be no true worry, but rather a simple reversion back to the mean. The ARM industry shouldn’t worry about this past week’s results, but its participants should continue analyzing and monitoring other economic indicators, many of which are available to all Members on KG Prime.