It has been a while since we’ve seen US indices drop more than 2% in a single day. The carnage speaks for itself: high-beta (higher volatility) stocks were hit harder, with the small-cap Russell 2000 plunging 4.43%, while big tech stocks, measured by the Nasdaq 100 (QQQ), fell 3.61%.
In fact, the markets have been declining over the past week, highlighted by headlines like the Dow Jones Industrial Average’s 10-day losing streak — its longest in 50 years. While these headlines can spook investors, reacting impulsively is rarely wise. Let’s break this down.
The recent market correction was triggered by the Federal Reserve’s latest FOMC meeting. While the expected 0.25% rate cut was delivered, the committee surprised markets by projecting fewer rate cuts for 2025 — only two. This adjustment implies that interest rates may not decline as much as previously forecast, forcing the market to realign with this new reality.
Interest-rate-sensitive sectors, like growth stocks and REITs, took a heavier hit in this adjustment.
The rate cut also affected bond prices, with longer-duration bonds seeing sharper declines. As a result, bond funds are feeling the pinch. Year-to-date, bond prices have already struggled due to rising longer-term interest rates. Beyond inflation expectations, fiscal policies under Trump — including increased government debt — have raised concerns about U.S. creditworthiness, driving interest rates higher to compensate for perceived risks.
The Fed’s cautious outlook reflects concerns about inflation. Proposed trade tariffs under Trump could increase the cost of goods, fueling price pressures. Simultaneously, a robust job market suggests the economy isn’t at risk of a slowdown. Together, these factors justify the Fed’s more measured approach to rate cuts, signaling apprehension about the economic landscape in 2025.
In an unexpected twist, Fed Chair Jerome Powell addressed Trump’s proposal to establish a U.S. Strategic Reserve to hold Bitcoin, stating that the Fed is not allowed to hold the cryptocurrency. Bitcoin dropped 5% following this announcement. However, its decline could also be attributed to broader market trends, as Bitcoin often moves like a leveraged tech stock. With QQQ down, Bitcoin’s movement may simply reflect this correlation.
Investors should remember that market volatility is a natural part of investing. It has been four months since the last significant volatility spike, measured by the VIX, which occurred in August amid recession fears and unwinding of the yen carry trade. That episode passed, and this one likely will too.
Despite the sell-off, the broader market trend remains upward. Prices are still above the 200-day moving average, signaling that the bull market isn’t over. While pullbacks are inevitable, they are not a reason to panic. The ability to stay psychologically resilient during such drops is the price investors pay for superior long-term stock returns. Stay the course.
