Why Is The S&P 500 Down So Much?

Key takeaways

• The S&P 500 suffered its worst day since June 2020 on Tuesday, slumping 4.32%, along with the Dow Jones which fell 3.94% and the Nasdaq Composite which was down 5.16%
• It was a dramatic reaction to the higher than expected inflation figures, which saw both headline and core inflation rise, in a month that analysts were expecting to see prices start to fall
• This all but guarantees a Fed rate hike at next week’s meeting, with a 32% chance that the increase could be as high as 1.00 percentage point

The S&P 500 had its worst day since June 2020 on Tuesday, with the index down 4.32% at market close. It comes off the back of the latest inflation figures from the US Bureau of Labor Statistics, showing inflation had grown again in August.

Price rose by 0.1% over the month, at a time when most analysts were predicting a reduction in the region of -0.1%. This saw headline inflation remain stubbornly high at 8.3% in the 12 months to August, down slightly from the 8.5% from last month.

Core inflation, which strips out more volatile prices such as food and energy, shot even higher. It increased by 0.6% through August which took the 12 month figure to 6.3%. This is a sizable jump over last month’s 5.9%.

Markets have reacted strongly and not in the right direction. Along with the S&P 500, the Nasdaq Composite was down 5.16% and the Dow Jones fell 3.94%. It’s the worst single day in 2022 for all three major indexes.

It’s not just the prospect of continued high prices that are market investors jittery, but also the likely reaction from the Fed.

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Fed rate hikes look to be aggressive and long term

The Fed chairman Jerome Powell has made statements recently that provide an insight into the plans to wrangle out of control inflation. Late last week he made some of his strongest comments yet, stating that “We (the Fed) need to act right now – forthrightly, strongly.”

It means that we’re almost certain to see hefty rate hikes at the next meeting in around a week’s time, and very likely a number of further hikes at subsequent meetings.

This is a major concern for businesses and households alike. For households, rising rates means the cost of debt becomes more expensive, along with other contract finance such as the types used for cell phone plans and car leases.

More money spent there means less cash available to spend on other items, which will put pressure on household budgets. This isn’t an unintended consequence of raising rates, it’s the whole point.

By giving consumers less money to spend, it means lower demand for goods and services and therefore prices that will either rise slower, or even fall. The extension is that many companies are likely to see their revenue fall as they compete for fewer consumer dollars.

The prospect of reduced revenue at a time when many industries are suffering from inflation in their own supply chain has sent markets spiraling.

The longer inflation remains this high, the more aggressive the Fed will need to be in order to get prices under control. There has been an expectation that an upcoming recession may be shallow and drawn out, in a term that has been coined a ‘pasta bowl recession.’

It may turn out to be wishful thinking, as higher rate rate hikes could lead to a harder economic landing than many analysts have been predicting.

Interest rate expectations are high and could go higher

Right now markets are pricing in a rate hike of 0.75 percentage points in the Fed’s September meeting. After these recent CPI figures, CME’s FedWatch now places the probability of a full percentage point hike at next week’s meeting at 32%.

The Fed has increased interest rates by three full percentage points over the past six months and a further rise next week would see interest rates at their highest levels since before the 2008 global financial crisis.

As of the last meeting in June, individual members of the Fed were expecting interest rates to almost 4% by the end of 2023. The ‘dot plot’ is an anonymous survey which outlines expectations over the short, medium and longer term, and it’s updated after each meeting.

Given the current situation the economy is in, this figure may rise significantly in the September survey and will provide some guidance to the market on what to expect over the coming year.

What can investors do in the current market?

We’re in an environment that takes some extra work to generate returns. In boom times, you can invest without too much thought and attention, and you’ll probably still do ok. We’re not in boom times now.

There are still ways to build and grow a portfolio, but the options aren’t necessarily going to be as obvious.

Pair trades are one great option to consider. A pair trade is when an investor takes a long position in one asset and a short position in another. It means that rather than making money on the outright performance of an asset, they make money on the differential between two assets.

One example of this is our Large Cap Kit.

In times of low or no economic growth, large companies tend to outperform smaller and medium sized ones. They usually have more stable revenue, more loyal customers, greater diversification in their income and less reliance on new customers to hit their numbers.

To take advantage of this, the Kit takes a long position in large companies and a short position in small and midsize businesses. It means that even if the overall market is flat or even falls, investors can still profit if large caps perform better than small and mid caps.

This kind of trade is often how big hedge funds help rich people make money in all markets, but we’ve made it available to everyone.

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