In the US, the Dow Jones Industrial Average (DJIA) — the oldest and most widely followed stock market index in the world — plunged nearly 2,000 points last Friday alone. It fell to 38,500 points. This is the lowest level in 10 months. What’s more, it stands for a shocking decline of close to 18% from the all-time highs we experienced last November. The recent slump has erased nearly a year’s worth of progress. Today, the index is much worse, well below the key 40,000 level.
Besides founding the DJIA, Charles Dow was the founder of the Wall Street Journal. The DJIA is an index of 30 of the most commonly and actively traded company stocks in the United States. The index simply sums the prices of all its constituent stocks. Then it multiplies that total times a formula, which is currently set at 0.152. The plunge had investors on edge as the index can be seen to fight against the wariness of interest rates, inflation, and looming fears of recession.
Factors Behind the Decline
Several issues are behind the DJIA fall over the past several weeks. One big part of the answer is the Federal Reserve raising interest rates. These rates have a direct impact on the cost of credit they provide. Since rising interest rates reduce consumer spending and corporate investment, they have a depressing effect on stock prices that is important to recognize. When the economy is too hot, or when inflation is high, the Fed increases interest rates to cool the economy through more expensive borrowing costs for businesses and consumers.
Interest rates are just one piece of the puzzle that’s impacting investor sentiment. The United States’ macroeconomic data, as well as what’s happening in global markets are huge factors. Recent reports showing persistently strong inflationary pressures and a weaker-than-expected US economy have increased that uncertainty in the market. Investors often react to these signals by repricing risk. As a consequence, they sell and reposition their portfolios further exacerbating downward pressure on major indices such as the DJIA.
Monetary policy tightening, ongoing geopolitical tensions, and market volatility are increasing the burden. Investors are becoming more alarmed at the prospect of conflicts and their effects on international trade and negative stock valuations. Note that the DJIA has obviously been under severe selling pressure. This has led it to lose 15% from its recent height of a little over 45,000 this year.
Trading Dynamics and Futures Contracts
Speculators use a wide range of tools to bet on where the DJIA will be in the future. One such tool are DJIA futures contracts, which let investors wager on the future direction of the index. These contracts allow traders to mitigate risk or benefit from expected price changes. Options provide you the right, but not the obligation, to purchase or sell the DJIA at a set price on a specified future date. This feature alone adds significant complexity to a trader’s strategy.
Upload a picture that illustrates any aspect of storytelling within your organization. Further, investors can invest in the DJIA via exchange-traded funds (ETFs), such as the SPDR Dow Jones Industrial Average ETF (DIA). These funds seek to match the index’s performance. They allow for convenient access to a DIJA that is a diversified portfolio of blue-chip stocks. Under today’s market conditions, even these more insulated investment vehicles experienced periods where they followed in lock-step with the broader index’s downturn.
Future Outlook for the DJIA
Worst case scenario, the DJIA has just recently plummeted back under its 200-day Exponential Moving Average (EMA) at 42,000. Bank analysts are scrambling, with some predicting even deeper losses to come. Most markets experts think that enough time will need to pass after for investor sentiment to settle. This is particularly problematic if inflation remains persistently high and growth in the economy continues to slow. The joint effect of higher interest rates and unknown macroeconomic shocks may have lasting effects on equity market turbulence.
We encourage investors to stay alert and avoid simplistic short-term thinking and pay attention to the long-term impact of their investment decisions. The reality of today’s market conditions underscore the dangers of equity investments. This is particularly the case in periods of economic turmoil.