From Cheering a ‘Goldilocks’ Economy to Fearing One, Stock-market Investors Have Changed Their Tune. Here’s What’s Next.

Throughout 2024, stock-market investors have enjoyed a "Goldilocks" economy, characterized by a balance that is neither too hot nor too cold. However, a series of weak U.S. economic data released in early August has sparked fears that a downturn may be imminent.

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On Friday, a disappointing July jobs report revealed slower payroll growth and a slight increase in the unemployment rate to 4.3%. Coupled with soft economic data from the previous day, this report intensified a significant market selloff.

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At the same time, prices for Treasury notes surged, causing yields to plummet, especially for shorter-term maturities. Investors are now betting that the Federal Reserve, criticized for delaying interest rate cuts, might need to initiate aggressive rate reductions at its September meeting.

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“Even if one isn't convinced the Fed will cut by 50 basis points in September, or by 25 basis points at each of the remaining meetings this year, it's clear that the 'Goldilocks' scenario has ended,” said Ian Lyngen, rates strategist at BMO Capital Markets, in a Friday note.

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Despite this sentiment, some investors believe the market's reaction was excessive. They argue that the economy is merely slowing down and the labor market, which had been overheated, is normalizing. Angelo Kourkafas, senior investment strategist at Edward Jones, told MarketWatch that the current market is experiencing a "growth scare." He emphasized that a "soft landing" involves both slowing growth and employment, and while this may lead to a more volatile trading environment, it does not necessarily signal the end of the bull market.

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The Cboe Volatility Index (VIX), often referred to as Wall Street’s “fear gauge,” surged to 29.66 on Friday, its highest level since March 2023. This index, which measures expected volatility over the next 30 days, ended the day at 23.39, above its long-term average of just below 20. Friday’s spike ended a 190-day streak of closes below 20, the longest such stretch since February 2018.

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The stock market took a severe hit, with the Dow Jones Industrial Average dropping over 600 points (1.5%) on Friday, leading to a two-day loss of 5.4%. The S&P 500 fell by more than 3% in the first two trading days of August, while the Nasdaq Composite dropped 4.7%, entering correction territory with a decline of at least 10% from a recent peak.

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Nicholas Colas, co-founder of DataTrek Research, noted that rising volatility is a hallmark of a "growth scare." He explained that such scares are common in midcycle markets and often peak in August, a historically volatile month.

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The market narrative has been shifting, with some investors and strategists warning of emerging cracks in consumer spending. This shift from inflation concerns to fears about economic growth has set the stage for a growth scare, a pattern often observed before the Federal Reserve initiates rate cuts.

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The result, as seen on Thursday and Friday, is that bad economic news is no longer perceived as beneficial for stocks. Earlier in the year, weak data reinforced expectations for Fed rate cuts, boosting the rally. Now, weak data fuels recession fears and accusations that the Fed has made a "policy mistake" by delaying rate cuts.

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It remains to be seen whether the economy is heading into a recession or achieving a soft landing. However, investors should brace for turbulent conditions, especially as we enter a period typically marked by increased volatility and seasonal weakness.

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Additionally, uncertainty surrounding the November presidential election adds another layer of unpredictability, analysts noted.

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A critical test for the market will come on Monday with the release of the Institute for Supply Management’s (ISM) July services index. A weak reading for the ISM manufacturing gauge on Thursday contributed to the stock-market selloff, so investors will be keen to see if the larger services sector also shows signs of weakness, according to Kourkafas.

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Following Friday’s jobs report, which highlighted concerns about the labor market, the weekly jobless claims data released each Thursday will also be closely watched. Furthermore, Nvidia Corp.'s earnings, expected later in the month, will be crucial as the company has been a major beneficiary of a tech-led, artificial intelligence rally.

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Keith Lerner, chief market strategist and co-chief investment officer at Truist, remarked that while the bull market deserves some benefit of the doubt, he had anticipated choppier waters entering July and expects this volatility to continue through the historically challenging months of August and September. "Indeed, with the market, it’s often two steps forward, one step back," he concluded.

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