In Wall Street Warriors, students write about important aspects of the finance field as well as news in the stock market. This week, sophomore Owen Ebner discusses sudden stock market plunge last week and why it happened.
The stock market plunged last week due to speculation of rising interest rates in bonds. Almost all major index funds fell drastically, with the S&P 500 down 4%, Nasdaq down 8%, and Dow Jones down 2% at their Friday lows.
For those who do not know, bonds are contracts where governments or individual companies borrow money from investors and reward them with interest. For years they have been at extremely low rates with the ten year treasury rate only 1.6%. Compared to the S&P 500, which averages a 10% return, the treasury rates are almost nothing. Due to this huge difference, investors have been putting their money into the stock market instead of into bonds.
However, there has been fear among investors that interest rates will soon begin to rise. If this happens, many investors would likely pull their money from the stock market and put it into much safer bonds. This has caused the stock market to fall, as investors are scared of a potential bear market ( which is a market when prices are falling).
As the Chair of The Federal Reserve, Jerome Powell sets the treasury rates. For a while he’s said he would not raise the treasury rates, but lately he has implied otherwise.
“We expect that as the economy reopens and hopefully picks up, we will see inflation move up through base effects,” said Powell to the public at a Wall Street Journal conference. “That could create some upward pressure on prices.”
Tech stocks have been the hardest hit by the potential rise of interest rates. This is because of a concept called discounted cash flow, which is how higher interest rates lead to inflation which leads to earnings being worth less. Tech stocks are typically valued very high because of hope that they will earn a lot of money in the future, but inflation would make that money worth less. If interest rates were raised, they would have to make even more money to be valued at their current market cap.
Although the stock market rallied this past Tuesday, with the Nasdaq having its best day since November, investors should still be wary of rising interest rates. It will be fascinating to see what ends up happening with interest rates and the outcome will drastically affect the stock market.