Some stock declines are more foreboding than others.
The selling that has driven down the markets continued Friday. The S&P 500 is down 9 per cent from its peak in September, and on pace for its worst month since the 2008 financial crisis. Swoons like this one can be unnerving, in part because they suggest all is not well with the broader economy.
But some of the selling may not augur much.
Take technology stocks, whose recent declines have played a big role in dragging down the overall market. Shares of big tech companies have soared this year. The tech-heavy Nasdaq composite index was up more than 17 per cent at its peak this year and 55 per cent since Donald Trump was elected president.
That left tech stocks vulnerable to a sharp sell-off.
That’s why the declines in shares of companies like Netflix and Amazon this month say more about their stock market valuations than the state of the wider economy.
Earlier this year, Netflix was trading at 110 times the earnings Wall Street analysts expected the company to make over the next 12 months, according to FactSet. That multiple is many times that of the wider market and suggests that investors were confident Netflix would deliver on its ambitious goals. But big questions, including its ability to finance its growth and rising competition, hang over the company. The drop in Netflix’s stock is thus evidence of healthy skepticism, rather than knee-jerk bearishness about its future.
But other selling cannot be so easily shrugged off.
Bank stocks are down a lot this year. That’s despite a strong economy, which typically leads to increased lending activity; rising interest rates, which have bolstered the profitability of banks’ core lending business; the tax cuts enacted last year, which had an outsize effect on bank profits; and hopes for deregulation. Yet the shares of Citigroup, the nation’s third largest bank, are down nearly 20 per cent from their high this year. Goldman Sachs, Morgan Stanley and Wells Fargo are all down about 15 per cent this year.
If bank stocks are a barometer for the economy, their poor performance points to some of the questions that keep investors up at night. Will Trump’s trade war soon start to do real damage to corporate earnings and the global economy? Will the Federal Reserve’s interest rate increases crimp economic activity by depriving companies and households of the loans they need to finance purchases?
A rout helps investors decide what’s worth really worrying about. With the U.S. economy growing strongly, they may soon decide they’ve been freaking out too much. A sustained upturn in bank stocks may show that their optimism is returning. But if they remain in the doldrums, real trouble may lie ahead.