Explaining the Recent Market Volatility

A few weeks ago, the parents of a colleague of mine hit a deer.

The parents had long expected this might happen.  The area they live in is dotted with deer crossing signs, so they knew the possibility was always present.  They always made sure to obey the speed limit and keep their eyes peeled.  Still, while driving home on a country road late one night, they were caught completely off guard when a deer suddenly sprang out of the darkness.  There was no time to slam on the brakes.  A collision was unavoidable.

Fortunately, the couple were fine.  But as they got out and surveyed the damage to their car, it was hard not to panic.  The hour was late, they were miles from home, and the front of their vehicle was completely busted.  Driving was impossible.  What were they to do?

The reason I’m sharing this story is because the markets have also hit a major obstacle recently.  An obstacle that investors knew was possible, even probable.  But, despite expecting it, the obstacle still caught investors by surprise…and is causing some to panic.

I’m referring to the unemployment rate.

On August 5, the Dow plunged by over 1000 points, the worst day in the markets since 2022.¹  This came on the heels of similar slides on Thursday and Friday the week before.  The main reasons for this drop are fairly simple to understand: A spike in unemployment, coupled with fear that the Federal Reserve has waited too long to cut interest rates.

As you know, the Fed has been keeping interest rates at their highest levels since the early 2000s.  The reason for this, of course, is to cool inflation.  High rates make it more costly to borrow money.  This prompts people to spend less, which incentivizes companies to lower prices in order to generate business.  Lower consumer prices means lower inflation.

But this drop in business activity can come with its own costs.  Companies pull back on hiring and cease to expand.  And if consumer spending slides by too much, the economy contracts and we enter a recession.  This is what’s known as a hard landing.  Inflation falls, but it pulls the economy down with it.

Mindful of this, the Fed has been trying to accomplish something historically difficult: a soft landing, where inflation falls, and the economy slows…but not enough to cause a recession.

For months now, the data has suggested the Fed might actually be able to pull it off.  While inflation hasn’t come down as fast as anyone would like, prices have cooled significantly.  The latest report showed inflation was at 3% in June compared to the same point last year.²  That’s not far away from the Fed’s stated goal of a 2% inflation rate.

Meanwhile, the economy has remained solid.  Our nation’s GDP, which measures the value of the final goods and services produced in the U.S., grew by 1.4% in the first quarter of the year, and is projected to have grown by 2.8% in the second.³  Even more impressive has been the labor market.  Despite historically high interest rates, the economy has continued to add hundreds of thousands of jobs each month.  Between February 2022 and April 2024, the unemployment rate stayed below 4%.⁴  At one point, unemployment dropped to its lowest point since 1969! ⁵

Very few countries can boast these kinds of numbers.  Inflation has been a global problem since the pandemic, and most nations have fought it using the same interest rate tactics that we have.  While some developed countries do have a lower inflation rate, most of these have experienced far slower economic growth…and much higher unemployment.

But… (There’s always a but, isn’t there?)

As long as interest rates remain high, the odds of an economic slowdown remain high, too.  It’s like driving on a country road late at night.  You may go months without even seeing a deer; years without hitting one.  But the deer are still out there, and the longer you drive, the greater your chances of a collision.  And in recent months, there have been more and more deer crossing signs in the economy.  In May, unemployment rose to 4% for the first time since January 2022.⁴  Wage growth has been slowing down.  Spending at restaurants and retailers has fallen.

Because of this, and because inflation has continued to cool, most investors have been expecting the Fed to begin cutting rates sometime this summer.  (September is a common prediction.)  Not by much, of course, probably just 0.25%.  But enough to add a little more juice to the economy without allowing inflation to heat up again.  This expectation has been a big driver of market performance this year.

But then the latest jobs report came out. The economy only added 114,000 jobs in July.⁶  That’s much lower than what economists had expected.  Furthermore, the unemployment rate ticked up to 4.3%, the highest it’s been since October 2021.⁶

Now, you might be thinking, “If unemployment is up, doesn’t that make it even more likely the Fed will cut rates?  Isn’t that what the markets want?  Why are investors panicking?”

Those are great questions.  But remember: The markets move based on expectation.  Investors already expected the Fed would cut rates.  That’s partly why the markets have been up for most of the year.  In other words, those expectations were already priced in.  But now, investors are wondering: “Did the Fed wait too long to cut rates?  Did we miss our chance at a soft landing?”

So, let’s look at why the recent jobs report matters…but why it does not mean we should panic.

The reason it matters is because it shows that high interest rates really are starting to have a chilling impact on the broader economy.  It also matters because, historically, rising unemployment can be like driving a semi-truck.  Once it gets going, it can take a lot of time to stop.  (Economists have a saying that unemployment rises like a rocket but falls like a feather.)

This means the jobs report is definitely something to take seriously.  But there are several reasons why panic is the exact wrong response.

First, if you put the numbers in context, you will see that a 4.3% unemployment rate is not particularly high.  In fact, historically, it’s still extremely low.  Furthermore, some of the data suggests that the main reason behind higher unemployment is because more people are entering the labor market and looking for a job than previously, not because of mass layoffs.

The second and most important reason?  We expected this.  We’ve all known, from the beginning, that higher interest rates would eventually cause a slowdown in spending and a rise in unemployment.  From the Fed’s perspective, higher rates are supposed to do this, so long as it doesn’t get out of control.  It’s the only way to bring down inflation.

Which brings me back to the story I started with, and the couple who hit the deer.

When the couple first saw the damage, their first instinct was to panic.  But then they remembered: they expected this.  They had talked about it happening.  Which means they already knew exactly what to do.  They knew what numbers to call.  What information to collect.  How to stay safe, how to get home, how to get their car towed, how to get a loaner, how to get a fair insurance payout.  None of this made the process fun, of course.  They would still rather have never hit a deer at all.  But the end of the story?  About a week later, they already have a new car they are very happy with, and which is already mostly paid for.

As investors, that’s what we have to do too.  Remember that we expected this, and that we have already factored it into our plans.  We’re not going to guess how high unemployment will rise, or how the markets will react.  Instead, we’ll pay attention to the deer-crossing signs, obey the speed limit, and drive cautiously.  If something happens, we’ll remember that we already have contingencies in place, so we never need give into panic.  Does that make market volatility fun, or easy?  No.  But it does mean that we can get through it, and then continue on our way.

Here at Avenues to Wealth, our job is to look at all new data and then determine whether it requires us to adjust our strategy.  Should that happen, we’ll let you know immediately.  In the short term, don’t be surprised by continued volatility — August and September are historically two of the most volatile months of the year anyway.⁷  In the meantime, though, my advice to you is to enjoy the rest of your summer.  Hop in the pool, go on a picnic, take a road trip!  My team and I will pay close attention to the markets so you don’t have to.

As always, let me know if you ever have any questions or concerns…and please do watch out for actual, literal deer.  Have a great month!

¹ “Dow tumbles 1,000 points,” CNBC, https://www.cnbc.com/2024/08/04/stock-market-today-live-updates.html
² “Consumer Price Index Summary,” U.S. Bureau of Labor Statistics, https://www.bls.gov/news.release/cpi.nr0.htm

³ “GDP, Second Quarter 2024,” Bureau of Economic Analysis, https://www.bea.gov/news/2024/gross-domestic-product-second-quarter-2024-advance-estimate

⁴ “Civilian Unemployment Rate,” U.S. Bureau of Labor Statistics, https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm

⁵ “Unemployment rate 3.4 percent in April 2023,” U.S. Bureau of Labor Statistics, https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm

⁶ “Job growth totals 114,000 in July,” CNBC, https://www.cnbc.com/2024/08/02/job-growth-totals-114000-in-july-much-less-than-expected-as-unemployment-rate-rises-to-4point3percent.html

⁷ “Average S&P 500 Performance by Month,” Reuters, https://www.reuters.com/graphics/USA-MARKETS/SEPTEMBER/zdvxozbwqpx/

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