Why is the Market Moving so Dramatically?
How the Stock Market Rebounded from Its Worst Day in Years
A Quick Recovery Reflecting Market Fundamentals
Last week, the stock market experienced significant volatility, raising fears of an impending recession and triggering widespread investor panic. Despite this turbulence, the market made a swift recovery, nearly erasing the severe losses it had suffered earlier in the week.
Volatility and Recovery
The S&P 500, after experiencing its worst trading day since 2022, rebounded sharply, marking its best trading session since the same year. By the week's end, the index had almost entirely recouped its losses, closing down just 0.05%. This rapid recovery was largely driven by a reassessment among traders, who realized that the fears of an imminent recession and the impact of the Japanese stock market selloff had likely been exaggerated.
Investor Sentiment Shift
Experts noted that the initial panic selling quickly turned into a buying opportunity as investors snapped up discounted shares. Callie Cox, Chief Market Strategist at Ritholtz Wealth Management, explained in a blog post that when market expectations are lowered significantly, any news that isn't disastrous can feel like relief, prompting a rush back into the market. She added, "When lots of investors brace for a punch – or sell their stocks – they tend to discover that the actual punch doesn't hurt as bad."
The Trigger: A Disappointing Jobs Report
The stock market's downturn was initially triggered by a weaker-than-expected jobs report released earlier this month. U.S. employers added only 114,000 jobs in July, far short of the anticipated 185,000. Additionally, the unemployment rate rose to 4.3%, its highest level since October 2021. This disappointing data fueled fears of a potential recession and increased calls for an interest rate cut.
Impact of Japan’s Interest Rate Hike
Compounding the market's woes were interest rate hikes by Japan's central bank. These hikes led to the unwinding of a popular "carry trade," where investors had borrowed Japanese yen at low interest rates to invest in other assets, including U.S. stocks. As Japan raised rates, investors began selling off these assets, causing stock prices to fall. Japan's Nikkei 225 index dropped over 12% in a single day, its worst performance since 1987. However, the index quickly rebounded, gaining 10% the next day and stabilizing over the rest of the week.
This pattern of sharp decline followed by rapid recovery was mirrored in U.S. markets. Avanidhar Subrahmanyam, a finance professor at UCLA, observed that "People saw a buying opportunity and stepped in," describing the episode as "simply a panic followed by a correction."
Historical Context and Market Resilience
Wells Fargo Investment Institute noted that between 1980 and 2023, the S&P 500 posted a positive return in 82% of calendar years, even though it experienced declines of at least 10% in nearly half of those years. This historical perspective suggests that a market downturn doesn't necessarily lead to poor annual performance.
Before the volatility last week, the stock market had been performing exceptionally well in 2024. By early August, the S&P 500 had risen more than 14% for the year, driven by strong corporate profits, enthusiasm for artificial intelligence, and optimism about an economic "soft landing." However, this strong performance also led to concerns that stocks had become overpriced, making the market vulnerable to bad news.
Conclusion: A Quick Recovery Reflecting Market Fundamentals
Despite initial panic, the market's rapid recovery indicated that fears were overblown. According to Jay Ritter, a finance professor at the University of Florida, the rebound reflected a recognition that the strong stock performance this year was largely driven by robust corporate profits, a fundamental metric that continues to support market gains. "U.S. earnings have gone up so much more than the rest of the world," Ritter said. "So the stock market has gone up a lot."
In summary, while the market's volatility last week highlighted investor fears and the potential for rapid declines, the quick recovery demonstrated the resilience of the market and the underlying strength of corporate profits, which continue to drive long-term growth.