Fears rise that plunging U.S. stocks could pose risk to economy if volatility continues

Traders work at the New York Stock Exchange on Friday.

Jan. 15, 2016 5:35 PM PT

The financial market turmoil plaguing the new year intensified Friday as major U.S. stock indexes plummeted, raising concerns that the nation’s still-recovering economy might falter if the tumble continues.

“Volatility, constant headlines about increased risk of recession and a slowing global economy are going to make the average American very nervous,” said Lindsey M. Piegza, chief economist at brokerage firm Stifel Nicolaus & Co.

For now, the risk of recession is low, economists said. But it’s rising.

The Dow Jones industrial average plunged more than 500 points before recovering somewhat. It closed down 390.97 points, or about 2.4%, at 15,988.08, the lowest since August. The broader Standard & Poor’s 500 index declined about 2.2%, falling 41.51 points to 1,880.33.

And the Nasdaq, which is heavily focused on technology stocks, fell nearly 4%. The index closed below 4,500 for the first time since October 2014.

So far this year, the Dow and S&P are down about 8%, wiping out all the gains since August. The Nasdaq is off more than 10%, shedding more than a year’s worth of gains.

Oil prices tumbled about 5% Friday. International Brent crude and the U.S. benchmark West Texas intermediate crude closed the day at less than $30 for the first time in more than a decade.

“There’s a real sense of total uncertainty about where people should invest,” said Jerome Booth, chairman of New Sparta Asset Management in London. “Markets are remarkably confused.”

The tumult raised the prospect that the Federal Reserve might hold off any more interest rate increases. The Fed inched up a key short-term rate last month for the first time in nearly a decade.

But William Dudley, president of the Federal Reserve Bank of New York, said Friday in a speech that he and other central bank policymakers would watch the economy closely to determine if more rate hikes were called for.

The rapid descent in stocks reflects real problems and fears of what could materialize. Many emerging economies and those dependent on oil, metals and other resources already are slumping, with countries such as Brazil having fallen into deep recession. That’s partly because of slowing growth in China, which has hurt the prices for commodities as well as international trade more broadly.

But fundamentals in the Chinese economy haven’t changed much in the last few weeks. Neither has the global oil market.

What’s changed is the level of uncertainty and doubts about the outlook. China’s main stock market, which has entered bear territory by falling 20% from its recent high last month, and weakening currency have heightened fears that the Asian giant is slowing more than official statistics suggest.

Oil prices, meanwhile, continue to get hammered because of a persistent abundance of production despite softening global demand. That’s thanks in part to the heavy U.S. investment and drilling activity of recent years and persistent pumping by major suppliers such as Saudi Arabia. Investors also are concerned that international sanctions on Iran are close to being lifted, which would allow that nation to ship more oil into the world market.

These concerns are now weighing on practically every corner of the globe.

“There should be more volatility as we go through this,” said Chris Christopher, director of consumer economics at IHS Global Insight. “But the fundamentals of the U.S. economy, especially as it involves the housing market and the consumer, are rather bright.”

Stock trends are seen as a forward-looking indicator. But the latest retreat, in part, also reflects a kind of payback after several years of strong stock gains supported by hefty stimulus from the Federal Reserve, said Eric Stein, co-director of global fixed income for Eaton Vance, a Boston asset management firm.

U.S. stock values now are “broadly in fair-value range,” he said, although that doesn’t mean markets will settle down right away.

Mark Sincavage, owner of a home-contracting and excavating firm in Blakelsee, Pa., says he hasn’t made any big changes yet in his spending because of the recent financial market turmoil. “You still have to live your life,” he said.

But the 55-year-old, who is winding down the third-generation business and looking toward retirement, was a little rattled.

“There’s instability in China, ISIS is a major concern worldwide,” he said. “We’re all integrated now; it’s a world economy.”

The turmoil on Wall Street was triggered by tumbling markets in Asia and Europe overnight. The U.S. sell-off was exacerbated by downbeat economic data.

The Commerce Department said Friday that retail sales fell 0.1% in December from the previous month. And the Federal Reserve reported that industrial production declined 0.4%.

Consumer confidence so far this month is up slightly from December, according to preliminary data released Friday from Thomson Reuters and the University of Michigan. Economists said it’s too soon for the effects of the market volatility to hit average Americans.

“The fundamentals driving consumer spending and housing are intact,” said Gary Schlossberg, senior economist at Wells Capital Management, noting low gas prices and recent signs of wage growth. “But when you see the turmoil, that could have an unnerving effect.”

It usually takes a sustained stock market downturn to slow the economy. If that happens, the fallout could be worse than usual.

The American economy depends a lot more on high-income consumers than it did decades earlier. Those households own the bulk of the stocks and would be prone to cut back as their portfolio values shrink.

From 2009 to 2012, consumption by the top 5% of U.S. households grew almost 14%, while spending by the bottom 95% rose 3%, according to research by economists Steven Fazzari at Washington University and Barry Cynamon at the Federal Reserve Bank of St. Louis.

“All of this suggests that affluent consumption has been the engine of a disproportionate share of the growth of the U.S. economy in recent years,” Fazzari said Friday.

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A recent study by Moody’s Analytics found that for every dollar in stock wealth that’s lost, consumer spending declines by 6 cents.

“A 10% decline in the stock market flushes out about $2 trillion in wealth,” said Mark Zandi, Moody’s chief economist. “If the slide continues, I think the impacts will start to mount and it will be a problem.”

One of the first signs of serious trouble would probably be announcements by companies that they are putting off investments or cutting costs.

Consumers could put travel plans or discretionary purchases on ice. And as more businesses and individuals followed suit, that would spill into the job market and spiral into the broader economy.

“If [job growth] starts to go, it’s going to be very difficult to stay out of a recession,” said Carl Tannenbaum, chief economist for Northern Trust in Chicago.

Six months ago, Tannenbaum reckoned there was a 5% chance of such a grim scenario happening this year in the U.S. On Friday, he put the odds at 20% to 25%.
Twitter: @jim.puzzanghera Twitter: @don.lee

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