Why Stock Market Is Crashing: Why The US Stock Market Is Crashing

The US stock market is off to a rough start in 2022.

The S&P 500, which is widely considered the primary benchmark for U.S. stock market performance, fell 13.3% during April, the biggest four-month drop to start a year since 1939. The index continues to fall in May and was down 16% year-to-date as of Tuesday's close, approaching the 20% threshold that some investors see as confirmation of a bear market.

For the Nasdaq Composite, which is heavier in tech stocks, the decline has been more severe, falling some 25% year-to-date.

WHAT ARE WEIGHTING EQUITIES THIS YEAR?

The S&P 500 started the year more than doubling from its lows in March 2020, a rise that reversed almost immediately when the calendar shifted to 2022.

The main factor cited by investors and analysts to explain the market's weakness is the change in Federal Reserve policy. As the pandemic took hold, the U.S. central bank rolled out emergency policies to stabilize the economy that investors said also encouraged the buying of stocks and other riskier assets. 

But at the start of 2022, the Fed signaled that it was moving towards a tighter monetary policy to stem runaway inflation, which is a significant change in the investment environment.

WHY HAS THE FED PIVOT DAMAGED EQUITIES?

In March, the Fed raised interest rates for the first time since 2018, raising them by 25 basis points. Earlier this month, the central bank raised rates another 50 basis points - the biggest move in 22 years - and Fed Chairman Jerome Powell signaled that similar increases could follow as it is also beginning to unwind assets accumulated during its fight against the effects of the pandemic.

These decisions weighed on stocks in several ways. While stocks have risen through most Fed-rate-hike cycles, some investors fear runaway inflation and high commodity prices will force the central bank to tighten rates more aggressively. , which could hurt growth and push the economy into a recession.

At the same time, expectations of Fed policy tightening pushed previously dormant bond yields higher. The yield on the 10-year U.S. Treasury has already roughly doubled this year to 3%, the first time it has risen above that level since late 2018 when the Fed was nearing the end of its last currency cycle. tightening.

With yields rising, bonds are a more competitive investment compared to stocks, with the 10-year Treasury yield about twice the level of the S&P 500 dividend yield.

Higher bond yields in particular tarnish the appeal of technology and other high-growth sectors, which are valued for their potential cash flow and lose their appeal as bond yields rise. Investors said that impact was reflected in excessive declines in some post-pandemic growth bets, with the Russell 1000 Growth Index down 24% this year.

WHAT OTHER FACTORS COULD CONTRIBUTE TO THE WEAKNESS IN EQUITIES?

Beyond the change in the Fed, Russia's war in Ukraine has fueled further economic uncertainty. For example, the unrest caused a supply shock that helped push up the prices of oil and other commodities, while triggering particular concerns about the European economy.

Other factors that have caused equity volatility recently include concerns about China's economy. Lockdowns in the country to control COVID-19 have weighed on production activity there.

WHAT ARE THE SIGNS INVESTORS ARE LOOKING FOR TO STOP THE LOWS?

Investors would like to see indications that US inflation is peaking so the Fed can take a step back from potentially more aggressive actions. Wednesday's release of the Consumer Price Index for April is the next key report to watch.

Some investors are interested in technical indicators, such as the S&P 500's ability to sustain key levels, such as 4,000, as well as particularly large days of bearish volume to "wash out" sellers, or the CBOE Volatility Index reaching some peaks.