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Why August has been such a wild ride for the US stock market

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For the third time in two weeks, the S&P 500 appears poised to fall by at least 2% on Wednesday. The latest drop comes after the bond market flashed a warning sign about the U.S. economy, and it continues a longer streak of abrupt moves in stock prices.

The U.S. stock market has lurched higher or lower by more than 1% on six of the 10 trading days so far this month for one primary reason: Traders are worried about the pace of economic growth ahead.

For the first time since December 2005, the yield on the 10-year Treasury note on Wednesday fell below the two-year rate, a phenomenon that's been a reliable indicator for recessions in the past. Fresh threats in the U.S.-China trade war have also stoked concerns on Wall Street about a possible recession.

Bank of America's global economist sees an one-in-three odds of a recession in the next 12 months, up from a prior estimate of about 20%. Similarly, a closely watched measure from the Federal Reserve Bank of New York puts the odds of a recession by next July at 31%.

In recent weeks, traders have rushed to sell stocks and buy assets that historically are less risky. Gold prices have surged and bond yields have fallen to near-record lows. Even so, this kind of activity isn't unusual for August. This month has typically been the weakest of the year for the S&P 500 in the past decade.

3 reasons professional investors are concerned

1) Trade

Several trade-related surprises in recent weeks have rattled Wall Street. On August 1, President Donald Trump threatened additional tariffs on $300 billion worth of Chinese goods. A few days later, China retaliated by letting its currency, the yuan, fall to its lowest level against the dollar in more than a decade.

Since then, both countries have backed off a bit. China stabilized its currency and the U.S. said it will delay new tariffs until December 15, rather than September 1 as previously planned.

But this prolonged trade spat causes uncertainty. Goldman Sachs recently trimmed its forecast for U.S. economic growth because it believes the trade war will have a larger-than-expected impact — and could even trigger a recession.

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2) Interest rates

The Federal Reserve cut interest rates for the first time since the Great Recession in light of slower economic growth. Even so, corporate profit continues to slow, and some investors believe further rate cuts are needed to stimulate business activity and avoid what's known as an earnings recession, when corporate profitability falls in two consecutive quarters.

Recession fears can have a snowballing effect. Many professional investors rush to buy assets that are considered safer during times of uncertainty. When traders are more eager to buy bonds, yields get pushed lower while gold prices surge. As those markets flash warning signs, more traders feel the incentive to sell.

3) The inverted yield curve

The yield on the 10-year Treasury note fell below that of the two-year security on Wednesday. When the yield on longer-term Treasurys is lower than the yield on shorter-term Treasurys — creating what's known as an inverted yield curve — it shows investors see the risk of a slowdown ahead.

An inverted yield curve is one of three recession indicators that professional investors track. There have been five inversions like this current one since 1978 and all preceded a recession, but by an average of 22 months, according to data from Credit Suisse.

How this August compares to other Augusts

August is typically a sleepy month for the stock market, the final hurrah of summer when many traders are on vacation. But having fewer people around can change the dynamic and increase the likelihood of abrupt swings in the market.

In four different Augusts since 1999, there have been at least 10 daily moves in excess of 1% in either direction — or about half the time, like so far this month — according to data analyzed by Grow. By comparison, the S&P 500 had daily moves of such magnitude about 28% of trading days in the past 20 years.

The S&P 500 has slumped more than 4% so far this month, but it's important to remember that this index most recently set an all-time high on July 26. In the past 10 years, the S&P 500 has fallen an average of nearly 0.8% in August — the worst month of the year during that period, according to data compiled by LPL Financial. Even so, the market has ended higher seven of the past 10 years, by an average of more than 11%.

What's next for the market

Trade likely will remain a key issue for the market throughout the remainder of August and into September, when the next round of talks among U.S. and Chinese leaders is expected. But the questions about the pace of economic growth, both in the U.S. and globally, is hardly new — and may not go away anytime soon.

The S&P 500 was up more than 20% through late July for a strong start to the year. Many market watchers warned that the market probably wouldn't experience similar gains in the latter part of 2019 and there likely would be movement.

But this type of market bumpiness can create opportunities for long-term investors who have the time to ride it out, because, historically, downturns have ended in upturns.

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