Our stock market is starting to crack. Investor confidence is rapidly dissipating. And changes in the way Wall Street works mean that the impact on your retirement portfolio could be far more severe than you may realize.
With the S&P 500 index down nearly 8 percent from its February peak, the U.S. equity markets are approaching bear-market territory, signaling a growing consensus in corporate America that a recession may be around the corner. After declining for three months in a row, consumer confidence is at its lowest level since July 2022, according to the University of Michigan index. Retailers are suffering: Ralph Lauren stock fell 19 percent in the last month alone. There are plenty of other stocks that are tanking, too.
Some of this was entirely predictable. The markets have been on an upward tear for the past eight years, hitting record highs both in the first Trump administration and under President Joe Biden. We were probably long overdue for the inevitable correction. The question, though, is how ugly this one will get. If history is any guide, it could get pretty bad: Financial reckonings tend to happen once every 20 years or so, and we are nearly 17 years out from the devastating financial crisis of 2008.
This time feels different because the damage is at least partly inflicted by the nine-week-old Trump administration, which recently signaled its determination to impose disastrous tariffs, even if doing so unleashes a recession. Corporate executives and Wall Street are rattled.
President Trump is lighting the match. But truth be told, there is a lot of bone-dry kindling lying around, thanks in large part to how the buying and selling of stocks has changed in the past 15 years, since Wall Street regulations were changed — making many ordinary retirement portfolios a whole lot more exposed to some of the highest-priced stocks we’ve seen in our lifetimes, which many believe are poised to return to earth.
Federal regulations put in place in the wake of the 2008 financial crisis curbed the role that big banks play in trading stocks and bonds. But in doing so, they also paved the way for a whole slew of new, less regulated but increasingly powerful pools of capital controlled by the likes of Citadel, Point72 and Millennium Management to step into the vacuum.
While big banks once had professionals who would accumulate buy and sell orders on behalf of customers and who thus could perhaps talk customers out of poor investment decisions, the new players rely on lightning-fast computers that are programmed to follow strict rules about how little money can be lost before changing direction. So when investor sentiment goes south, it is more difficult to stop the hemorrhaging in the markets once it starts, making the situation much more volatile.
Sweeping changes in the way stocks are bought and sold are now intersecting with another big shift: collective changes in how we have decided to invest our savings.
You may remember a time when money managers like Peter Lynch advised individuals to “buy what you know.” But the reign of such stock pickers has long passed as investors shifted away from actively managed funds like Mr. Lynch’s Magellan Fund toward index funds, which are pools of capital that are automatically invested in a selected list of stocks, whose mix is changed only occasionally. Not only do such funds charge lower fees, but they also outperformed the actively managed funds in recent years. Little wonder, then, that they are widely popular, with roughly half of the money in the equity markets — some $13 trillion, according to Morningstar — invested in index funds or other types of passively invested funds that target certain types or groups of stocks.
That all sounds good, except for one other thing. The same new players, like Citadel, that have taken over some of the specialist trading functions on Wall Street also make money by fomenting volatility in the markets, trading in and out of stocks daily and generating more momentum behind a handful of winners. And the faster winners accelerate, the more money index funds automatically plow into them. This cycle helps explain how seven technology stocks — the so-called Magnificent Seven, which includes Apple, Meta, Nvidia and Tesla — now make up nearly a third of the value of the entire S&P 500.
The more a stock price increases and the more expensive it is relative to its earnings, the riskier it becomes to own. Despite recent declines, Tesla remains so overvalued by the traditional measure of a multiple of its earnings that it deserves its own galaxy. That hasn’t slowed investors’ appetite for it, though: In the past five years, Tesla stock went up 750 percent. Meanwhile, Apple’s went up more than 275 percent, and Nvidia’s more than 2,000 percent. If you are invested in a standard S&P index fund, as many are, nearly one-third of your money is basically subject to the vicissitudes of seven stocks whose value has risen exponentially in recent years and are anything but bargains.
A correction may already be underway. The outsize government role that Mr. Trump is allowing Tesla’s chief executive, Elon Musk, to play might be amusing for both of them, but it has spelled serious financial trouble for Tesla shareholders, including many ordinary people invested in index funds. In the past month alone, Tesla stock has lost nearly a third of its value. And as a charter member of the Magnificent Seven, Tesla’s fall has exacerbated the decline and the volatility in the equity markets during the past seven weeks, given the revamped market structure. Tesla was great to own on the way up, of course, but there’s plenty of pain to go around now that it appears to be a falling knife.
Now might be a good moment to check on your retirement funds, because what you may have thought were safe index funds are actually tilted heavily toward the biggest and baddest technology stocks. And they could be suddenly facing a financial reckoning.
