Wall Street on edge after a week of wild swings

After a wild week in the markets that rekindled fears about the strength of the U.S. economy, investors are wondering what comes next.

Until recently, Wall Street was focused on inflation, hoping that its slowdown would lead the Federal Reserve to cut interest rates, giving support to stocks. The recent havoc has brought back an additional consideration: the risk that markets could tank in response to signs that the economy was slowing too fast.

For now, markets seem to have recovered a sense of calm. On Thursday, the S&P 500 index recorded its biggest gain, up 2.3%, since late 2022, propelled by an often overlooked weekly report on unemployment claims that came in better than expected. After a rise of 0.5% on Friday, the index still ended lower for a fourth consecutive week, but only marginally - a significant turnaround after a global rout Monday.

Investors will be tested in the next few weeks. New data on U.S. inflation is set for release Wednesday. A week later, Fed Chair Jerome Powell is scheduled to give a speech at a marquee economics forum. Wall Street will anxiously await what he says about markets and the economy.

Earnings reports due this month from bellwethers such as Walmart will also give hints about the strength of the consumer underpinning the economy, while results from chipmaker Nvidia will be pivotal given the influence of tech giants over the S&P 500.

Investors are braced for more turbulence.

"We're not over this yet," said James Stanley, a senior strategist at StoneX. "We're not through the woods."

A similar story is unfolding around the world. In Japan, which bore the brunt of the recent selling, stocks remained volatile but pared losses after their biggest drop since 1987. The Europe-wide Stoxx 600 index enjoyed four days of gains that erased its drop Monday.

Taking a step back, the S&P 500 is up roughly 12% for the year. For all its short-term ferocity, the magnitude of the recent sell-off since the index peaked in mid-July has not been particularly remarkable, historically speaking. Stocks fell a total of 8.5% through the end of Monday. Since 1985, the median sell-off in any given year is around 10%, according to Goldman Sachs.

"Pullbacks happen all the time and we think of this as just a pullback," said Binky Chadha, chief U.S. equity strategist at Deutsche Bank.

What's more, the sell-off occurred during low summer trading volumes, meaning that while the price swings were dramatic, they occurred with relatively few people selling. Data from EPFR Global showed that for the week through Wednesday, investors actually added more money to funds that buy U.S. stocks, extending a run of net inflows to six weeks.

Chadha said he was not lowering his expectation for where the S&P 500 would end the year. "If anything, I would consider raising it," he said.

Despite this sober optimism after such a dizzying week, nervousness remains about where the economy could go next, rather than where it is now.

Recent events have cemented expectations that the Fed will cut interest rates in September. When that happens, stocks typically rally. But if the Fed is pushed to cut more aggressively than it had previously expected, it could signal that the economy is under more pressure than the central bank would like.

Goldman Sachs analysts, who also maintained their target for the S&P 500 by the end of the year, wrote that they expected a stock rally as the Fed begins to cut rates, "as long as the economy is not on the brink of recession."

For now, the consensus is that the economy is not yet there. But concerns about the likelihood of a so-called soft landing have heightened investors' focus on the big data releases coming up.

The rotation away from big tech companies toward more unloved areas of the financial markets such as smaller companies, banks and real estate firms - usually a sign of broad economic optimism - appeared to be delayed as the dust continued to settle from Monday's mayhem. The Russell 2000 index of these smaller firms, which are more exposed to the economy, has given up most of its recent gains and sits just 2.6% above where it started in January.

"Financial markets have momentarily stabilized after concerns about hard-landing risks caused a brief Wile E. Coyote moment," analysts at Bank of America wrote in a note Friday. "From here, the data will have to tell us what kind of economy we have: One that is slowing gradually, or one that is slowing sharply," they added.

If inflation data disappoints next week, for example, "that could spark more of those recession fears," Stanley said.

And if the fundamental strength of the economy holds for now, there are other worries looming on the horizon - like the acrimonious U.S. presidential election or rising tensions in the Middle East - as well as more technical reasons that the stock market could continue to wobble.

Even market bulls are girding for a period of pressure.

"I would not be surprised if equities remain in a bit of a funk for a while," Chadha said.

This article originally appeared in The New York Times.