Dow plunges 666 points amid rate-hike fears after strong jobs report

Adam Shell | USA TODAY

Show Caption Hide Caption What happens in a stock market melt-up Some Wall Street pros say the stock market is entering a melt-up phase, which could affect your 401(k).

The Dow tumbled 666 points Friday — its sixth-biggest point loss ever — and suffered its worst week in two years as investors turned skittish about spiking interest rates, dashing much of the optimism that had been powering stocks to record heights.

In a matter of days, the mood of investors has swung from euphoria to real concern that the stock market, which as recently as last week was hitting new highs, might be at the start of its first sizable decline in years. The market, which is down about 4% from its recent peak, hasn't suffered a 10% drop, or "correction," since February 2016.

While Friday's point drop, its worst since the financial crisis, might seem big and cause anxiety for investors who might have gotten too complacent, the Dow Jones industrial average's 2.5% slide Friday didn't even come close to a top-20 percentage drop for the popular stock gauge.

On Black Monday, for example, during the stock market crash of Oct. 19, 1987, the Dow dropped 22.6%, which back then amounted to 508 points.

But Wall Street pros note that Friday's plunge was not due to the economy showing signs of weakness, but instead came as growth is picking up, CEOs are confident and corporate profits are robust. It also follows a bullish period, with the Dow sprinting 25% higher last year and the broad market last week posting its best January in 20 years.

That favorable backdrop is why there is no "reason to change one's strategy based on the last few days," says Bill Hornbarger, chief investment officer at Moneta Group in Clayton, MO.

While the U.S. stock market suffered a paper loss of $1.25 trillion this week, it has still generated $7.4 trillion in wealth since Election Day 2016, according to Wilshire Associates.

Ironically, Friday's selloff was sparked by continued good news in the job market, with the government reporting that the economy created 200,000 jobs in January, and data showing wages for U.S. workers rose at their fastest pace since 2009 -- a pick-up in pay that spurred fears of a spike in inflation.

Good news for workers is viewed as not-so-good news for stocks, as it suggests the economy is in danger of overheating. That could pressure the Federal Reserve to hike short-term interest rates more aggressively than expected, says Russell Price, senior economist at Ameriprise Financial.

Some analysts fear the Fed may hike rates four times this year, more than the three they have already signaled.

"Temporarily, good news may be bad news for the stock market," Price says.

The big change in the market mentality is the fear that borrowing rates, which have been near record lows since the financial crisis and were a catalyst behind the current nine-year bull market for stocks, might be on the verge of moving dramatically higher.

"The major driver of the selloff is the awakening to the new interest rate environment," says Erik Davidson, chief investment officer at Wells Fargo Private Bank.

A big selloff in the U.S. government bond market Friday sent the yield on the 10-year Treasury up above 2.85%, its highest level since January 2014.

Higher rates mean bigger borrowing costs for consumers and businesses, which can slow economic growth.

Despite the steep Dow drop, now is not the time for investors to get spooked out of the market, says Kate Warne, chief market strategist at Edward Jones, a St. Louis-based financial services firm.

Investors must take the bad week in stride, as business conditions remain healthy and company earnings are expected to benefit this year from corporate tax cuts.

"It's not time to panic," Warne says, noting that the broad Standard & Poor's 500 stock index is down just 3.9% from its Jan. 26 record high.

Indeed, the market has experienced one of its longest periods of relative calm on record. Prior to the selloff, it had gone 448 days without suffering a drop of 3% or more, the longest run on record.

And it hasn't yet endured a 5% drop since June 2016 -- the second-longest streak without a so-called "pullback" in history.

"Pullbacks normally occur about three times a year," says Warne.

Stocks also seemed to be dragged down by political turmoil, after the Republicans released a controversial and now-declassified memo alleging that the FBI and Department of Justice abused their surveillance authority to target President Trump's 2016 presidential campaign.

More: 401(k) investors: Is a 'melt-up' happening in the stock market?

More: Dow starts February with more swings, 37-point gain after a strong start to the year

More: Bitcoin: If currency crashed, plunge would harm its investors but not economy