Traders work at the New York Stock Exchange (NYSE) on August 5, 2024, in New York City.
Spencer Platt | Getty Images
Any number of suspects could be blamed for Monday’s market decline, from worries about the economy and an apparently slow response from the Federal Reserve to a slowdown in a popular global currency trade and worries about corporate profits.
All of these played a role in some shape or form, and each helped tell a story of a changing investment landscape that likely hasn’t fully played out.
“This is a regime change that has a big impact on sentiment,” said Robert Teeter, chief investment strategist at Silvercrest Asset Management. “The market got a little bit ahead of itself in that run that it had. Now we’re back to where we were in April and May, and it was a brutal correction because it was a very big wake-up call.”
This call came in the form of a sale that saw the Dow Jones Industrial Average lose more than 1,200 points early Monday and briefly put it S&P 500 down 9% from July’s record high.
Market averages are falling
Bond yields fell as bond traders bet on both a slowing economy and a Fed forced to cut interest rates soon.
Concerns about the state of the economy began on Thursday, when disappointing data on manufacturing and layoffs fueled worries about the economy. Those worsened on Friday when the Labor Department reported lower-than-expected job creation and a rising unemployment rate in July that triggered a reliable recession signal known as the “Sahm Rule.” Traders soon began pricing in aggressive Fed rate cuts after expecting the central bank to do little the rest of the year.
Indeed, the central bank was not far from investors’ minds as sentiment grew that the Fed is waiting too long to ease benchmark short-term lending rates, currently at 23-year highs.
Market prices on Monday implied a near certainty that the Fed will cut by half a percentage point at its September meeting and will follow with reductions in November and December that will cumulatively amount to 1.25 percentage points.
A ‘perfect storm’ sinks markets
“It’s just a perfect storm of slowing growth, a lot of positions and risk-on sentiment coming to a head at the same time,” said John Belton, portfolio manager at Gabelli Funds. “The market will really follow the data now and you will have the backdrop of monetary policy easing.”
Along with concerns about economic and monetary policy, the market had to deal with the easing of a popular trade that involved borrowing in cheap currencies like the Japanese yen and buying higher-yielding currencies – the “carry trade” that helped propel global markets with liquidity.
An unexpected interest rate hike last week by the Bank of Japan as well as currency intervention there have fueled fears that the carry trade is over. The yen rose sharply on Monday and Japanese stocks had their worst day since Black Monday in October 1987.
Corporate profits have also been questioned.
The second-quarter earnings season has seen 78% of companies beat earnings forecasts, but just 59% top revenue estimates, according to FactSet. In addition, it was the outlook from some Silicon Valley fliers that have raised market concerns and companies such as Nvidia — down 11% over the past five days — paid the price.
Finally, geopolitical concerns remain, with markets worried about the situation in the Middle East and Ukraine, as well as a rapidly changing political landscape in the US that has seen presumptive Democratic nominee Kamala Harris in a virtual tie with Republican Donald Trump in many polls.
Put that in the context of a highly valued market — the S&P 500 last week was trading at 20.7 times forward earnings, or about 15% above its five-year normal — and it had all the makings of a selloff waiting to happen .
“This is the confluence of a very high market that is soaring and riding on a lot of emotion and sentiment. For several months now, the bullish trade has been the successful trade,” said Michael Farr, CEO of Farr, Miller & Washington. .
“While people make fundamental arguments that give them comfort, everyone in the back of their minds knows that things don’t go up 30% in six months,” he added. “Well, when you’re in a period of huge profits, it’s very easy to take profits. It’s a much easier decision to say I want to take my chips and go home here.”
There is no time to panic
But Farr, like many on the Street, doesn’t think it’s time for the Fed to take drastic action.
Even with the rising unemployment rate and weakening manufacturing picture, most other economic indicators are good.
A reading on Monday in the services sector was better than expected, with nearly 8.2 million jobs still available and The Atlanta Fed is watching growth of 2.5% in the third quarter, albeit with a limited data set.
“Two weeks ago, the economic data was pretty reasonable, the employment data was reasonable,” Farr said. “But within a weekend, we’ve been scared of the end of the world and it happens every time.”
None of those surveyed Monday said they believed it was time for investors to make major changes.
Silvercrest’s Teeter said he is simply advising clients to rebalance, while Gabelli’s Belton said he will watch for when the current downtrend changes.
“I see it as an opportunity, a huge overreaction, and that doesn’t mean it might not continue,” Farr said. “Momentum breeds momentum up and down. People say they hate volatility, which is a lie. What they hate is downside volatility. Nobody, nobody hates upside volatility.”
