Wall Street hits shocking summer sell-off, as recession fears start to soar again

A summer marked by spurts of all-out exuberance on Wall Street got a bucket of ice water suddenly thrown on it as recession fears once again resumed.

"Wall Street is now convinced that the risk of recession has been elevated and investors are bailing out of the recent highfliers, be they U.S. or Japanese stocks, in a 'sell first and ask questions later' mindset," Sam Stovall, chief investment strategist for CFRA Research, told the Detroit Free Press on Monday before trading began.

On Monday, the Dow Jones Industrial Average lost an incredible 1,033.99 points by the end of the day. But, given the highs of the market, stocks were actually down 2.6%, nothing close to a double-digit range. The Dow closed at 38,703.27 points.

U.S. stock valuations were very high to start, making the market vulnerable, Stovall said, to the "slightest alteration in economic or fundamental forecasts."

On Monday, General Motors stock closed at $39.95 a share, down 2.96% or $1.22 a share. Ford Motor Co. closed at $9.71 a share, down 3.19% or 32 cents a share. Stellantis closed at $15.74 a share, down 2.42% or 39 cents a share.

Japan's Nikkei index foreshadowed signs of potentially dramatic disruptions on Wall Street on Monday morning. The Japanese stock index fell 12.4% in a day Monday, which, according to CNBC, was the worst day for the index since the widespread global market meltdown on Oct. 19, 1987, often referred to as “Black Monday.” The Nikkei index has tumbled by more than 20% from an all-time high on July 11.

Why the Dow fell so quickly from record highs

What happened since July 17 when the Dow closed at its record high of 41,198.08 points? The Dow is now down 6.05% in less than three weeks.

Suddenly, it seems we're staring at a long list of what-ifs.

What if that much talked about recession is really around the corner this time? The Dow fell below the 40,000 mark on Friday — losing 610.71 points or 1.51% — to close at 39,737.26 points after concerning news about jobs as the U.S. employment rate hit 4.3% in July, up from 4.1% in June.

The U.S. jobless rate was 3.5% in July 2023. And the current rate of 4.3% is the highest level since October 2021 when the rate was 4.5%.

For perspective, the U.S. jobless rate spiked from 4.4% in March 2020 to 14.8% in April 2020 during the height of the pandemic's economic fallout.

While a jobless rate in the 4% range now isn't alarming, analysts say the upward trend in recent months gives reason to be concerned about potentially rising risks of a recession ahead.

“We are sliding closer to a recession,” said Patrick Anderson, CEO of the Anderson Economic Group consulting firm in East Lansing. “The economy is weaker.”

The latest jobs report gives more solid signs of a slowdown that has been ongoing for the past six months or so, according to Anderson's estimate.

“When the number of people who are unemployed consistently ticks up for three straight months, it’s telling you that something has changed,” Anderson said.

The U.S. jobless rate was 3.9% in April, 4% in May, 4.1% in June and now 4.3% in July. We started 2024 with a national unemployment rate at 3.7% in January.

Much of the job growth has been taking place in government-supported industries, Anderson noted, health care, education, state and local government, federal government. But elsewhere in the economy, some industries that produce goods have been cutting payrolls.

What's Sahm saying about the Sahm Rule

Many are now talking about the “Sahm Rule,” which is flashing a warning signal here.

Claudia Sahm, a former Federal Reserve economist, created the Sahm Rule, which indicates that the initial phases of a recession begin when the three-month moving average of the U.S. unemployment rate is 0.5 percentage points or more above its lowest level during the previous 12 months. According to data from the Federal Reserve Bank of St. Louis, the Sahm Rule reading reached 0.53 points in July.

This time, according to some, including Sahm, things could be different since we are moving off some historically low jobless rates below 4%.

And frankly, I'd add, nothing about the economy seems all that predictable, after the pandemic and the flood of cash from stimulus payments. Yet, the potential for a recession continues to exist.

I spoke with Sahm on Monday afternoon by phone and she shared some reassuring words about why she doesn't see a reason right now to panic about the economy.

Sahm explained that the Sahm Rule — which was designed to identify recessions in real time — was developed in early 2019 when she was an economist at the Federal Reserve Board of Governors in Washington, D.C.

The rule, she said, is an indicator of an ongoing recession. Normally once the rule is triggered, it would show that the U.S. has been on average already three months into a recession. That's based on historical data going back to 1970.

"What we learned on Friday is that the unemployment rate rose yet again, and the Sahm Rule triggered," Sahm said.

"It's saying the Sahm rule has triggered, and I, Sahm, am saying we're not in a recession," she told me Monday.

Other information about the U.S. economy — such as consumer spending and payroll growth — indicate that the economy is still growing, she said.

"Things have slowed down a lot but we are not contracting. A recession is a contraction," said Sahm, who is now chief economist for New Century Advisors in Washington, D.C. Sahm has a connection to the Midwest, holding a Ph.D. in economics from the University of Michigan.

The National Bureau of Economic Research officially determines when a recession starts and ends but, typically, that pronouncement doesn't happen until well after your Uncle Joe, Auntie Helen and everyone you run into knows darn well we've been in a recession. The last recession lasted two months in early 2020; the recession before that one ran 18 months from December 2007 through June 2009.

The Sahm Rule was designed to enable the federal government to move more quickly, instead of waiting for that official word, to provide relief early in the game as it's needed. It was designed to help stabilize the U.S. economy as expansions end and contractions begin. The idea was to provide direct payments to individuals early in a recession and then continue annually when the recession is severe.

The Sahm Rule was a supporting actress, as Sahm puts it, in the stimulus checks issued during the COVID-19 downturn.

"Am I worried that we are headed toward a recession based on the Sahm Rule and other data? Yes," she said.

"As the unemployment rate rises, it often builds some momentum."

But right now, she maintains the Sahm Rule can be viewed cautiously because two forces drove up the jobless rate in recent months — a temporary uptick in the labor supply, which includes a rapid increase of immigrant workers over the past two years, as well as weakening demand for workers.

Weakening demand is often a sure sign of a recession. An uptick in labor supply? Not so much.

Right now, the issue isn't just tied to layoffs or weaker demand, which is the crux of the Sahm Rule, she said. Some of what's going on now, she said, involves a transition problem as new workers are matched up with jobs. The positive aspect, she said, is that more workers can help industries offer more goods and services in the long run, helping the economy grow.

It's hard to distinguish how much is going on from each of those two forces. "If it was easy, I would have done it," she joked.

"The recession odds have risen," she said. But she maintains that markets had an "outsized reaction" Friday to the July jobs data and the triggering of the Sahm Rule.

"The real economy is not in a freefall," Sahm said.

What role will the Fed play here?

Another economic what-if: What if the Fed has ended up waiting too long to cut rates?

On top of the disturbing trend for the jobs market, analysts are increasingly concerned that the Federal Reserve could have kept interest rates too high for too long. Inflation has slowed significantly and high rates slow down economic growth more than what might be needed here.

The first rate cut is a move that's needed to keep the economy going and start rates back on a path to more normal levels. The Fed raised rates 11 times since March 2022 to fight skyrocketing inflation after the pandemic. The last Fed rate hike was in July 2023.

Keeping interest rates consistently high gives consumers more reason to hold back on making big purchases, such as taking out a car loan to buy a car or taking on a mortgage to buy a home. The Federal Reserve kept the short-term federal funds rates at its range of 5.25% to 5.5% after its meeting last week, a range it has been at for the past year even as inflation has cooled off.

The bad vibe that many, but not all, consumers feel about the U.S. economy could ease up a bit when the Fed finally takes its foot off the brakes, as I wrote back in June when the Fed didn't cut rates at its June 12 meeting. But we're still stuck here waiting for a rate cut.

Sahm said the Fed, in her opinion, should have begun cutting rates in June. But she said it's doubtful that the Fed will initiate an emergency rate cut in the weeks ahead, as some suggest could be needed. The Fed typically doesn't take such drastic action unless there is a financial crisis or other emergency. Such a move could give markets more reason to panic, some experts say.

The Fed's next scheduled meeting is Sept. 17 and Sept. 18. Many had already expected a small rate cut in September, but some wonder if the rate cut could be larger then.

What will happen? Who knows? But that's the kind of wild time we're looking at here.

For many everyday investors, the latest shock for stocks might seem out of the blue this summer. Most of the dramatic headlines, after all, have focused on the presidential election. President Joe Biden dropping out of the race on July 21. Former President Donald Trump surviving an assassination attempt on July 13. Stocks seemed to be chugging along.

"We get lulled into false sense of security and then the true stock market rears its head," said Sam Huszczo, a chartered financial analyst in Southfield.

We are dealing with negative economic reports, such as the July report on jobs. "But nothing dramatic enough to justify this reaction," Huszczo said.

"Despite the potential of the beginnings of an economic recession," he said, "the outlook for corporate earnings growth remains optimistic and earnings are the biggest factor in how stocks perform over time."

Right now, he said, he wouldn’t recommend trying to predict market tops and bottoms.

Summer's fun on Wall Street, though, clearly came to an abrupt end a month before Labor Day.

Contact personal finance columnist Susan Tompor: stompor@freepress.com. Follow her on X (Twitter) @tompor.