Factors Potentially Driving the Dow Jones, S&P 500, and Nasdaq Down and Why Investors should not Panic Excessively
In the past month, it's been a brutal reminder that the stock market wouldn't be the dynamic, up-and-down ride we know it without the opportunity for equities to fall as well as rise.
Following an impressive two-year streak for the Dow Jones Industrial Average (^{DJI} -0.62%), S&P 500 (^{GSPC} -1.07%), and tech-heavy Nasdaq Composite (^{IXIC} -1.71%), these Wall Street behemoths have taken a nosedive. Over a four-week period from Feb. 19 to Mar. 13, the Dow, S&P 500, and Nasdaq dropped respectively by 8.6%, 10.1%, and 13.7%. With the Nasdaq's double-digit dip, it finds itself firmly in correction territory.
When stocks start their descent, investors scramble to guess the possible bottom. Although it's not something that can be pinpointed accurately ahead of time, there are three factors that suggest more downside for the Dow, S&P 500, and Nasdaq:
The Dow, S&P 500, and Nasdaq are likely to keep falling
Uncertainty is typically the bane of every Wall Street player. The clearer the future outlook, the more contented investors are–even if the news isn’t always positive. However, nobody on the Street can find a silver lining in the current tariff policy enforced by President Trump.
To protect American jobs and level the playing field for domestic goods, Trump wields tariffs as leverage. While this strategy might work for finished products, tariffs on inputs, which are goods used to create finished products, could make U.S.-made goods even pricier.
Moreover, the daily fluctuation of Trump's take on tariffs–altering implementation dates and goods exemptions–only adds to the prevailing uncertainty. Until that uncertainty lifts, the Dow, S&P 500, and Nasdaq may continue to slide.
The second factor that can push the Dow, S&P 500, and Nasdaq lower is the Federal Reserve Bank of Atlanta's GDPNow forecast predicting that the first-quarter GDP will plummet by 2.4%. In less than a month, the Atlanta Fed has revised its GDP projection from nearly 4% growth to what would be the steepest quarterly GDP decline since 2009, outside the COVID-19 pandemic.
An economic contraction would logically impact corporate earnings and, in turn, the stock market.
Finally, the third catalyst that could see the Dow, S&P 500, and Nasdaq fall further is valuation. Despite the S&P 500 and Nasdaq's official corrections, this market remains one of the priciest in history.
The Shiller P/E ratio, a popular valuation metric, reached a peak of 38.89 during this bull market cycle in December. More than double the average Shiller P/E of 17.22 across the past 154 years, it's the third-highest reading during a continuous bull market. Whenever the Shiller P/E has surpassed 30 since January 1871, the Dow, S&P 500, and/or Nasdaq have eventually lost at least 20% of their value. If history repeats itself, all three indexes could have further to fall.
Image source: Getty Images
History repeats itself, but its lessons often go unheeded
To state the obvious, most investors aren't big fans of unpredictability, market volatility, and some of Wall Street's most influential businesses experiencing double-digit percentage drops over a short time frame. But these declines are normal, healthy for the stock market, and inevitable. No amount of fiscal or monetary policy modifications can stop stock market corrections from happening.
While large daily declines in the Dow Jones, S&P 500, and Nasdaq Composite can seem alarming, what's crucial for investors to understand–the key reason why they shouldn't be overly worried about the last month's events–is the nonlinear nature of investing cycles.
Stock market corrections, bear markets, and crashes are inherent parts of the stock market framework. However, these events aren't mirror images of bull markets.
In June 2023, analysts at Bespoke Investment Group gathered data comparing bull and bear market durations for the S&P 500 since the Great Depression (September 1929), highlighting the stark contrasts between investor optimism and pessimism on Wall Street.
On one hand, the average bear market lasted approximately 286 calendar days (around 9.5 months), with the longest S&P 500 bear market on record persisting for 630 calendar days during the 1970s. With a few exceptions, significant drops in the S&P 500 resolved relatively quickly.
On the other hand, the average bull market endured for 1,011 calendar days, or roughly three times longer than the typical bear market. More notably, 14 out of 27 bull markets, including the current one, extended beyond 630 calendar days.
The lesson here? Although stock market corrections, bear markets, and crashes can be unnerving, they are historically short-lived. Compared to bull markets, which can last for years and propel the Dow, S&P 500, and Nasdaq to unprecedented heights, corrections represent a temporary setback.
If investors exercise patience, every stock market correction offers a prime opportunity to invest at a discount in the stock market.
- Given the current economic climate, it would be prudent for investors to anticipate that the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite may continue to experience a decline, as uncertainty surrounding tariff policy and a predicted GDP plummet could have significant impacts on the stock market.
- One of the factors suggesting more downside for the Dow, S&P 500, and Nasdaq is the high market valuation, as the Shiller P/E ratio, a popular valuation metric, has reached a peak during this bull market cycle, surpassing the average Shiller P/E by more than double.
- In the past, whenever the Shiller P/E has surpassed 30, the Dow, S&P 500, and/or Nasdaq have eventually lost at least 20% of their value, indicating that history might repeat itself, potentially leading to further downturns for all three indexes.
- Despite the normalcy and occasional necessity of stock market corrections, pessimism is often prevalent among investors during such periods. However, it is worth remembering that while bear markets can be unnerving, they are historically short-lived compared to bull markets, and every correction presents an opportunity for investors to buy stocks at a discount.
