S&P 500 falls from record high to near bear market in 5 months: How did it happen so fast?

The year started with great optimism, with S&P 500 index touching a record high in January. Since then, it has been all downhill, with the index suddenly flirting with “bear market” territory, or down at least 20% from its peak.

Shell-shocked investors now look at their portfolios and wonder: What happened in these five short months?

It's difficult to point fingers when so many factors are likely contributing simultaneously. Perhaps it's because the Fed waited too long to raise interest rates, as inflation proved to be persistent instead of transitory. On top of that the supply chain snarled again, with the war in Ukraine and new COVID-19-related lockdowns in China tightening supplies of everything from oil and gas to wheat, technology and auto parts. Now consumers’ money is starting to run out.

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Chasing inflation

Surging inflation and how aggressively the Fed will have to act to tame it was the first weight on the market. In the 12 months through April, consumer prices rose 8.3%. That was slower than the prior month’s 8.5% clip but still near a four-decade high.

To help rein in inflation, the Fed raised its benchmark fed funds rate at its last meeting by 50 basis points, the largest one-time rate increase since 2000. Higher interest rates make borrowing more expensive and loans less likely, which dampens spending.

And Fed Chairman Jerome Powell said Americans can expect more increases this year, but even then he’s not sure it will be enough. If it isn’t, he said, the Fed won’t hesitate to ratchet up rates past 2% to 3%.

“We won’t hesitate at all to do that. We won’t,” he told The Wall Street Journal on Tuesday at the publication’s Future of Everything Festival.

Recession fears

After the economy unexpectedly contracted last quarter, more economists are predicting a recession on the horizon. And while the Fed works to tame inflation, economists say the central bank could add fuel to the fire by taking more money out of circulation.

"Recession risks have taken center stage on the carousel of concerns in recent weeks," Keith Lerner, co-chief investment officer at Truist, said in a note published Friday.

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"Historically, the S&P 500 has fallen an average of 29% around recession (median of 24%)," he added. "With the S&P 500 currently showing a peak-to-trough decline of almost 19%, the market is effectively already pricing in a 60%-75% chance of recession based on the average and median."

Global factors

As if that wasn’t enough, unforeseen global events have magnified inflation fears.

Russia invaded Ukraine in February, which catapulted oil prices to the highest levels since 2014 and lifted prices of fertilizer and metals including aluminum, platinum and nickel. Russia is one of the world’s top producers of all these items. Wheat prices also soared because Ukraine and Russia are big wheat exporters. And worse news: The fighting doesn’t look to end anytime soon.

Then China started locking down cities at the end of March amid new COVID-19 cases. That not only strained production of parts for everything from iPhones to cars, but it also delayed shipping of them as rail, port and trucking workers are locked in.

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“The situation in China remains highly uncertain, and more prolonged disruptions would pose upside risk to U.S. inflation in the second and third quarters and downside risk to U.S. growth,” Goldman Sachs wrote in a note last month.

These twin events are making the Fed's job even tougher and making businesses and markets even more nervous. The Fed has some control over demand by raising interest rates, but it can’t control supply, economists said.

Going broke?

The latest meltdown stems from surprise earnings warnings from two retail giants. Walmart and Target, like a one-two punch on back-to-back days, said that in the face of surging prices, consumers cut their discretionary spending faster than expected.

Consumers, flush with pandemic-era stimulus cash, had been keeping the economy humming. In April, nominal retail sales jumped 0.9%, which analysts touted as a sign the underlying economy remained strong.

“Despite the surge in prices weighing on their purchasing power, the U.S. consumer now appears to be single-handedly keeping the global economy afloat,” said Paul Ashworth, chief U.S. economist at Capital Economics.

But on Tuesday and Wednesday, Walmart and Target said consumers, particularly lower- and middle-income households, were starting to crack under the weight of inflation.

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Food costs soak up cash

“Not all of them can afford to absorb this,” Doug McMillon, Walmart president and chief executive officer, said on an earnings conference call. “We knew that we were up against stimulus dollars from last year, but the rate of inflation in food pulled more dollars away from general merchandise than we expected as customers needed to pay for the inflation in food.”

The shift out of discretionary spending isn’t surprising, but the timing was.

“I think it really surprised the market because everyone knows the consumer has been strong with cash savings and a tight labor market,” said Sarah Wyeth, retail and consumer analyst at S&P Global Ratings. “We all knew it would turn and at some point, inflation would eat into purchasing power and savings would dry up, but this shift is earlier than expected. We’ve now reached an inflection point. Spending won’t crater, but it’s harder for the middle- and lower-income consumers. It’s hitting them first.”

And that really spooked the market.

"As goes the consumer, so goes the economy and ultimately the market," said Brad McMillan, chief investment officer for Commonwealth Financial Network.

Contributing: Elisabeth Buchwald

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.

This article originally appeared on USA TODAY: Is S&P 500 headed into bear market? Index falls fast from record high