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Inflation fears cause more shivers on Wall Street

Taylor Telford
Washington Post

U.S. markets vacillated between positive and negative territory Thursday as investors continued to agitate over rising costs that are weighing down businesses and consumers.

A day after suffering its worst drop of the year, the Dow Jones industrial average ended the day down more than 230 points, or 0.75%. The broader S&P 500 index ended the day down 0.6%, while the tech-heavy Nasdaq eked out some gains, then reversed course and closed the day down 0.3%.

More: A bear market may be on the horizon. Here’s what that means

The S&P 500 remains within striking distance of a bear market – defined as a 20% drop from the most recent peak – after Wednesday's sell-off wiped out more than 4% off its value. It marked the index's worst day since 2020 and came after it already had notched its worst first four months of the year since 1939.

Earnings season has turned into a pileup of worries for investors, with weak performances from Target and Walmart serving as catalysts for Wednesday's sell-off. Both retailers reported spikes in fuel and compensation expenses, as well as growing signs consumers are spending a little less freely. Target shares, which lost more than a quarter of their value on Wednesday, erased another 5.2% on Thursday. Walmart stock also moved lower, falling another 2.75%.

"The extent of the impact of inflation on these giants of American retailing has woken investors up, once again, to the huge impact surging prices are having on every facet of the economy," Russ Mould, investment director at AJ Bell, said in commentary Thursday. Combined with hints from the Federal Reserve about more aggressive interest rate hikes, "and it's little wonder that stagflation fears – a slowing economy combined with inflation running hot – are stalking the markets once more."

The panic spread to other retailers, with competitors Costco, Dollar General and Dollar Tree racking up double-digit losses Wednesday. On Thursday, Kohl's slashed its 2022 earnings forecast, joining the chorus of household companies to warn of inflation's deleterious impacts to their business. Kohl's is facing pressure from activists to sell itself amid weakening performance, and the company said it expects bids from potential buyers to be imminent. Its shares nonetheless swelled 4.75%.

BJ's Wholesale rose 6% after it reported a 14% jump in first-quarter sales, with gasoline boosting its revenue. Bob Eddy, the company's chief executive, said in BJ's earnings report that its business model remains "more relevant than ever in the current inflationary environment."

Consumer spending is the primary engine of the U.S. economy, making up about 70% of the nation's gross domestic product. That's why the signs of struggle from retailers, grocers and wholesalers are troubling: Companies are facing tighter margins and swelling inventory, and they have yet to pass the costs fully onto consumers. If they do, inflation for the average household could get even worse, Mould said.

But if they don't, "operating margins will come under pressure, and if margins crack, then so do earnings," he said. "And that's not good at a time when investors are still paying lofty valuation for peak profits and near-peak margins" across the U.S. stock market overall.

The shaky retail performances bring a new dynamic to the volatility investors have had to navigate in 2022, including war in Ukraine and its consequences, supply chain headaches, roaring inflation and the ongoing challenges of the pandemic.

Now it seems that outlooks are darkening: JPMorgan said Wednesday that the market is pricing in a 70% chance of near-term recession, suggesting investors lack confidence that the Fed can rein in inflation without triggering a downturn. Fed Chair Jerome Powell himself has said the central bank should have moved faster to raise interest rates, and he said it hasn't ruled out more aggressive action if convincing evidence of cooling inflation doesn't appear.

The Fed has raised its benchmark interest rate twice this year, including by half a percentage point on May 4, and is expected to do so five more times this year to ease inflationary pressures. Fed officials have been attempting to pace increases so as not to smother economic growth, a difficult balance to strike. If the economy cools too quickly, it could fall into a recession, generally defined as two consecutive quarters of negative economic growth.

"The outcome of the Fed's actions is totally unpredictable, which is why markets are so volatile," Ryan Belanger, managing principal of Claro Advisors, said in commentary Thursday. Belanger said he expects the market to trade "near or in bear market territory for the coming months."

"It appears that we are headed toward a recession in the second half of 2023," Belanger said, "when the current tailwinds of a strong consumer and solid corporate financial strength potentially give way to higher interest rates and a declining wealth effect."

In times like these, "investors should become accustomed to significant downside and upside moves in stocks," which is common in periods of uncertainty.

As it stands, the S&P 500 is down more than 18% for the year, and the Dow is down nearly 14%. The Nasdaq, which has been heavily battered as investors rotated away from pricey tech stocks, is down more than 27% for the year, well into its own bear market.

Gas prices hit a fresh record high Thursday, with the national average for a gallon surging to $4.58 according to data tracked by AAA. Soaring energy prices are one of the challenges on the menu as the Group of Seven finance ministers meeting later this week to discuss global economic woes, as well as potentially deepening sanctions on Russia over its invasion of Ukraine. Europeans have discussed additional measures to deprive Russia of its revenue from oil and gas sales – the United States has already banned energy imports from Russia – but any such move could push prices up even further.