The deterioration of China's economy is terrible news for US markets, and perhaps for your portfolio.

Why Stock Market Volatility Is Spooking Investors

Many investors are profiting this year - the S&P 500 is around 14% higher in 2023. However, market losses have piled up in recent months, owing to mounting fears of contagion from China's economic decline. Inflation, Russia's war in Ukraine, and bank fragility in the United States have all worried Wall Street.

The Nasdaq fell 7.7% in August, while the S&P 500 fell over 5%. The Dow finished lower below its 50-day moving average on Thursday, a critical level that investors frequently perceive as a pessimistic indicator. This month, the index is down 3%.

 Worry & Greed Index, which examines seven indications of market emotion, showed signals of worry on Friday for the first time since March. This is a significant improvement from only one month ago, when the score was in "extreme greed" zone.

China's economy is in distress.

The deterioration of China's economy is terrible news for US markets, and perhaps for your portfolio.

According to the National Bureau of Statistics, China's consumer spending, manufacturing output, and investment in long-term assets (such as property, machinery, or other commodities) all decreased in July. Youth unemployment in the world's second-largest economy has frequently reached all-time highs. Beijing decided earlier this week to halt the distribution of the monthly data entirely.

In addition, China's growing real estate and debt crises has some investors concerned about the possibility of a "Lehman-like" event.

Meanwhile, tensions between the United States and China have risen as the world's two largest economies dispute over topics ranging from trade policy and technology to Russia's invasion of Ukraine.

"For most of the last two decades, China's economic growth has been a major driver of the global economy," according to Alex Etra, a strategist with data analytics firm Extant. This means that if China's economy slows, so will global economic growth.

"When economic growth throughout the world slows down, US stocks typically suffer. Additionally, as China is a significant consumer of commodities, some of that has to do with the direct exposure of US companies' sales in China.

Blame the Federal Reserve

In order to combat spiraling inflation, the Federal Reserve has raised interest rates by more than 5 percentage points during the past 18 months.

Wall Street appeared to be almost certain a few weeks ago that the Federal Reserve was almost done with its rate-hike program, which many experts had said would send the US into recession.

However, a number of compelling economic statistics have refuted those assumptions.

The Atlanta Fed predicted a staggering third-quarter GDP growth rate of 5.8% annualized, unemployment is still low, and consumer spending is solid, demonstrating how resilient the US economy has been.

Officials from the Fed are worried that prices might rise further. According to meeting minutes released this week, they said during their July meeting that additional interest rate increases might be required soon.

This hasn't pleased investors. The 30-year US Treasury bond yield reached its highest level since 2011 on Thursday, and the 10-year note recorded its biggest return since October 2022. As bond prices decline, bond yields rise.

Geopolitical upheaval

Global inflation is finally beginning to fall, but rising geopolitical tensions threaten to hike food and oil costs around the world. Russia's invasion of Ukraine has fueled fears of rising commodity prices, global economic insecurity, and security uncertainty.

Banks are still at risk.

Fears of contagion remain in the aftermath of the March regional banking crisis: The fund managed by "Big Short" investor Michael Burry sold 150,000 shares of First Republic Bank (FRC), as well as holdings in Huntington Bank, PacWest (PACW), and Western Alliance (WAL), as part of a major portfolio realignment that included a $1.6 billion bet against the broader stock market.

Bank shares slumped on Monday on news that Fitch Ratings warned of another downgrading of the US banking industry, which might harm the ratings of several significant American lenders.

Another factor contributing to recent turbulence is that few investors are paying attention.

The well-known Wall Street adage goes "sell in May and go away" since the summer, and especially August, is traditionally tumultuous for the stock market. This is largely due to fewer investors taking vacations and lower trading volumes. This decreased activity may result in increased volatility.

According to Morningstar, August has been the worst performing month for stocks since 1986.

This August has been unusually busy for this time of year. It's been jam-packed with economic statistics and major company reports. That indicates the remaining traders were attempting to stay afloat in a highly turbulent market.