Why the stock market is freaking out again

CNN

Analysis by David Goldman, CNN

(CNN) — Fear has set in on Wall Street, and stocks are having another miserable day.

The Dow tumbled more than 1,000 points, and the broader market plunged 3% Monday. The Nasdaq, full of risky tech stocks, dropped 3.5%.

All of that comes amid a global market selloff. Japan’s Nikkei 225 index nosedived 12% — its worst rout in history. All major Asian and European markets fell substantially Monday.

Three fears are emerging all at the same time to send markets into a tailspin Monday: Growing worries about a recession, concern that the Federal Reserve has failed to act promptly enough and a belief that big bets on AI may not pay off.

Recession fears

The most prominent is fear that the US economy is in much worse shape than previously believed — evidenced by Friday’s unexpected jump in the unemployment rate.

On Friday, the Bureau of Labor Statistics reported that the US economy added just 114,000 jobs in July — far fewer than expected — and the unemployment rate jumped to 4.3%. Although that’s not in and of itself an unhealthy unemployment rate, its sudden march higher is alarming: Last year, the unemployment rate was at its lowest level since the moon landing.

To be clear: The US economy remains strong. Last quarter, it grew way more than expected, boosted by still-robust consumer spending, which makes up more than two-thirds of all gross domestic product.

But recession fears are mounting. Goldman Sachs economists Monday raised the odds of a recession to one in four in the next 12 months. That’s still a “limited” case, because the economic data looks strong overall and the Fed has plenty of room to reduce rates from a 23-year high.

But Goldman’s recession chances are still 10 percentage points higher than they were before Friday’s jobs report, which it called “more concerning now.”

Fed concerns

The stock market had hit record after record this year, buoyed by falling inflation and the growing sense that the Fed would shift from its series of aggressive rate hikes and start to rate cuts, which can boost corporate profits.

But the Fed didn’t cut rates as many had hoped last week. The market increasingly views the Fed’s patience as a mistake.

The Fed is notoriously horrible at timing its rate cuts and hikes. It was way behind the curve on inflation and had to catch up with multiple historic rate hikes in 2022 to tame runaway prices. Likewise, some economists believe the Fed should have started cutting rates sooner.

Rate cuts could help support the job market by cutting borrowing costs for businesses and freeing up money for companies to spend on hiring. But policy decisions take time to work their way into the economy. As inflation has cooled dramatically in recent months and the unemployment rate has risen, some fear the Fed may be too late to act before slow hiring turns into rampant layoffs.

The Fed’s next meetings are scheduled for September, November and December, Analysts at Citigroup and JPMorgan predict the Fed will slash rates by half a point at its next two meetings. But that may be too late, and it may be forced to make an emergency rate cut before then.

An emergency cut — which hasn’t happened since the early days of Covid, is exactly what the Fed needs to do, said famed Wharton professor emeritus of finance Jeremy Siegel on CNBC Monday morning.

“It’s so far behind the curve right now. I mean the Fed is up in the bleachers,” said Siegel. “You take a look at the data; it’s not at all comforting.”

AI worries

Stocks had also been flying high over the past two years because of big bets on tech companies involved in artificial intelligence: Many hoped that AI would create another global industrial revolution.

But AI profits are basically nonexistent, and the unproven technology isn’t yet ready for prime time. Some fear it’ll never get there. Traders are beginning to unwind big trades on Apple, Nvidia, Microsoft, Meta, Amazon, Alphabet and other tech stocks that had been surging since the beginning of last year.

Warren Buffett — CEO of Berkshire Hathaway and a notoriously calm force when markets go haywire — is also ditching tech. He just sold half of Berkshire’s Apple stake, which is a troubling sign for the health of the tech sector.

Because those companies are each worth close to $1 trillion or more and make up an enormous chunk of the overall value of the S&P 500, when investors sell off tech stocks, that has a massive detrimental effect on the broader market.

What happens next?

Investors are running for the hills. They’re selling off oil, crypto and especially tech stocks. Instead, they’re pouring into safe havens like bonds, sending Treasury yields lower.

That could spell trouble for some folks’ retirement accounts. But people who are close to retirement could actually benefit if they have a heavy mix of bonds, which are benefiting from the flight to safety.

Lower rates, if the Fed follows suit with cuts, could help lower punishingly high mortgage rates, car loan rates and other consumer loan costs. It could mean, however, that people with money stored in savings accounts could yield less interest in the coming months.

One thing not to do: panic. This is not a market crash. Not yet, anyway. Investors are nervous, but not panicked. Monday’s rout, if it ends at current levels, wouldn’t even crack the top 100 worst days in market history.

The only question now: How long will this fear last before investors sense a buying opportunity?

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