Stocks plunged into bear market territory on Monday as investors increasingly worry that a recession or stagflation is on the horizon.
The S&P 500 fell nearly 3.9% at close to enter a bear market. A bear market is when an index drops to below 20% from a recent high. The S&P 500 has fallen nearly 22% since the start of the year, its most recent peak.
The Chicago Board Options Exchange volatility index is intended to gauge fear in the markets. The index was up more than 110% since the start of the year, an enormous leap that shows the extreme anxiety investors have about the economy’s future.
Stocks had previously entered a bear market last month, but they managed to claw back some of those losses before tumbling back into the red again on Monday. Also on Monday, the Dow Jones Industrial Average lost more than 875 points, and the Nasdaq composite shed about 4.7% of its value.
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The last sustained bear market was a short period of time at the start of the coronavirus pandemic. Prior to the pandemic, the last time the economy experienced a bear market was during the financial crisis more than a decade ago, which lasted for 517 days.
A driving factor behind the rout in the stock market is the Federal Reserve’s monetary tightening. After years of loose monetary policy, with interest rates at near zero, the Fed is now working to raise rates quickly in an effort to crush the country’s spiraling inflation.
Consumer prices increased an explosive 8.6% in May on an annual basis, the highest rate of inflation since the early 1980s. The Fed has indicated it plans to hike interest rates several times this year, which might mean the bear market will have some staying power. The inflation report came in hotter than expected and caused increased anxiety in the markets on Friday and Monday.
The central bank increased its interest rate target by a quarter of a percentage point in March and subsequently hiked rates by half a percentage point earlier this month.
The half-point hike is analogous to two simultaneous rate increases and shows that the central bank is growing increasingly more concerned about inflation. The last time the Fed made such an aggressive move was more than two decades ago.
By raising interest rates, the Fed hopes to slow spending. Some market-watchers fear that because the Fed is now moving so aggressively, it will slow the economy down too much and cause a recession.
Some investors have expected that if the stock market drops too precipitously, the Fed will intervene and pause its rate hike cycle or even slash rates, although given the historic levels of inflation, it appears that the central bank has no intentions of doing so, even if it means stocks will continue to crater.
Federal Reserve Bank of Kansas City President Esther George recently signaled that Fed leadership would not be drawn off course by stock market declines.
“I think what we are looking for is the transmission of our policy through markets’ understanding, and that tightening should be expected,” she said. “It is one of the avenues through which tighter financial conditions will emerge.”
There are also concerns about stagflation. Stagflation, a portmanteau of stagnation and inflation, is when inflation is rising at the same time that economic growth and the labor market are struggling.
The term is often used to describe the U.S. economy of the 1970s when both inflation and unemployment were high. At the time, many top economists thought such a situation was impossible because it was believed that high inflation could be traded off for lower unemployment.
Bear markets and stock selloffs do not necessarily indicate a recession, but they often go hand in hand.
The National Bureau of Economic Research, a private academic group, defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
While the gross domestic product declined by a 1.4% annual rate in the first quarter of this year, most forecasters are projecting that there will be positive growth for the second quarter, a reassuring prediction for those fearing a recession.
Still, many economists believe a recession could be right around the corner.
Goldman Sachs assigns a 35% chance of a recession in the next two years, while Wells Fargo’s economic model projects a 30% chance of a recession occurring in the next six months alone.
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As the Fed continues to raise interest rates, all eyes will be on the stock market to see what happens next. Top Fed officials are set to meet in June and July, and many investors foresee more of the aggressive half-point hikes following those gatherings.