Stock market gets ugly: Here's what you should do

Wall Street is back to its old tricks and scaring everyone with a 401(k) with some ugly triple-digit declines.

The Dow Jones Industrial Average closed at 25,479.42 Wednesday, down 800.49 points or 3.05%. On Thursday, U.S. stocks were only able to make up a small part of what was lost the day before, as investors remain concerned with the outcome of an ongoing trade war between the U.S. and China.

The Dow – and, likely your 401(k) – had a miserable day on concerns that an obscure economic signal is flashing red for a recession. Here are answers to some questions to avoid sheer panic.

What should someone with a 401(K) do at this point?

Hard to keep saying over and over again that you should sit tight, but most analysts say if you've got time on your side, you should wait it out.

"If your time horizon is five years or longer, the current 6% sell-off, and even a potential 10% (decline) should not compel you to be a seller," said David Sowerby, managing director and portfolio manager for Cleveland-based Ancora Advisors.

Even if you're nearing retirement, you don't want to panic. Don’t forget you are likely to spend 20 or more years of your life in retirement, Sowerby said.

At the same time, though, you can expect more volatility ahead and you'll have to learn to deal with the ups – and downs – of the Dow.

Recession watch: Six financial moves to make when the economy slows down

Why investors are worried: Treasury yields invert, sounding economic alarm bells

The market can test logic – and your patience – in the near term.

A market correction is part of the game. For 75 years, Sowerby noted, the U.S. stock market has averaged a correction or downturn of 10% or higher about once a year.

Currently, the major stock indexes are down 6% to 7% from July 26 highs on concerns about trade, tariffs and an economic slowdown.

Taking your own situation into account is more important than chasing shocking headlines.

If you're going to work another 20 years or so, continue contributing to your 401(k) on a consistent basis, including taking some risk on stocks.

If you're nearing retirement or retired, reevaluate your risk tolerance and consider being more cautious about your investments, including having less exposure to the stock market. But again, don't make moves because you think you can time the market.

Why is something called the 'yield curve' making headlines?

Wall Street has been watching an economic indicator known as the yield curve for more than a year.

The reason: It's one hot recession warning sign.

In general, rates for 10-year U.S. Treasury notes should exceed short-term rates, such as the two-year note, if you're expecting the economy to remain strong.

Think about it, you want to be paid more money for the risk of lending money for 10 years than you'd want to be paid for a shorter-term loan.

The yield curve inverts when short-term rates turn higher than long term rates, as they did during trading in the bond market Wednesday. The last time we saw this happen was in June 2007 – and that was a sign of the next recession. The Great Recession ran from December 2007 through June 2009.

Now, the question becomes: Is this a sign of long term anxiety – or a shorter-term blip?

Every recession has been preceded by an inversion in the yield curve. But at the same time, not every inversion in the yield curve has led to a recession, said Sam Stovall, chief investment strategist for U.S. equities at CFRA Research in New York.

A year ago, economists predicted that many investors would become very alarmed if the yield curve inverts. And that prediction proved to be correct.

So are we falling into a recession here?

Economists say no. Nothing is guaranteed, of course, but many say the economy is showing some healthy signs, including decent housing starts and consumer confidence levels. Unemployment is low. People are buying and selling houses.

"We don't think we're headed into a recession right away," Stovall said.

Plenty of worries remain – such as the U.S./China trade war and its fallout.

Pressure is building on the Federal Reserve to cut rates at the next meeting in September, which would be the second rate cut in 2019.

Some say a recession is increasingly likely in the next several months, perhaps sometime later in 2020 on concerns about President Donald Trump's trade policy.

Mark Zandi, chief economist for Moody's Analytics, said the inverted yield curve is strongly signaling that a recession is in the near future.

"And if not a recession, certainly much slower growth," Zandi said.

There's a growing concern, he said, that Trump's trade war is triggering mounting economic damage.

The odds of a recession within the next 12 months to 18 months are better than even, if the president continues to pursue his trade war, Zandi said.

On Tuesday, the White House appeared to acknowledge added tariffs on Chinese goods threaten the U.S. economy.

Trump postponed a group of new tariffs until Dec. 15 on Chinese goods, such as clothes, computers and other consumer items in light of the holiday shopping season.

The duties had been set to go into place Sept. 1.

"Yes, the president didn't want to be called the Grinch who stole Christmas," Zandi said.

"The next round of tariffs on Chinese goods will be on things Americans buy as Christmas presents. The tariffs mean they will have to pay more for these things, including toys, iPhones, computers, clothing, etc."

Robert Bilkie, CEO of Sigma Investment Counselors in Northville, Michigan, said that while the shape of the yield curve is a reasonable predictor of future economic activity, it's not an infallible indicator.

"Due to the low unemployment rate and the shortage of workers in the United States, I would put the odds of a recession at less than 25%," Bilkie said.

"Companies are loath to lose good employees and as a result, are unlikely to initiate layoffs, a factor that has defined past downturns – creating a self-fulfilling prophecy."

Contact Susan Tompor: 313-222-8876 or stompor@freepress.com. Follow her on Twitter @tompor. Read more on business and sign up for our business newsletter.

This article originally appeared on Detroit Free Press: Recession worries drive down stock market: What should you do?