Investors Face A Sophie's Choice Of Bad Decisions
MARKETS
Investors scrambled into damage control mode as stocks took a brutal beating. Weak economic data drove the sell-off, spreading losses across all three major indexes. The end-of-week dive came after the Federal Reserve held rates steady, prompting a growing chorus claiming the Fed is falling behind the curve. Whispers of a 50 basis point cut in September are echoing through global markets. The bigger risk could be that the Fed reacts too slowly as signs of an economic slowdown build, leaving traders facing a "Sophie's Choice" of bad options.
So, what sparked the panic? A series of recessionary signals. The market, which had previously thrived on the "bad news is good news" mantra, got a reality check. On Thursday, a jump in jobless claims and an abysmal read on ISM manufacturing undercut risk sentiment, sending 10-year yields tumbling below 4%. The final nail in the coffin was the underwhelming US payrolls report and an “unexpected” rise in the jobless rate. It’s clear now: bad news is unequivocally bad news. Gone are the days when disappointing data was a reason to cheer for potential Fed rate cuts. It’s time to break out the popcorn and watch the market panic unfold.
Typically, falling yields anticipating Fed cuts aren't bad for stocks. However, stock pickers scramble for cover when recession warnings start flashing in the bond markets.
Market action this week showcased the extreme volatility we've been experiencing. Investors have darted in and out of asset classes and sectors with the speed of a day trader on espresso, finally landing for Treasuries and Yen as the latest safe havens.
These wild market swings highlight the challenge of making sense of economic data and earnings reports, especially when the Fed’s stance seems to flip-flop between being stimulative one day and signalling growth concerns the next.
Investors are confronting two big questions: What if the U.S. economy isn't as strong as we thought, and what if the epic tech rally went too far?
Adding to the mix, we're entering the dog days of summer when Wall Street's vacation schedules kick in, thinning out market liquidity. As seasoned traders know, lower liquidity often results in more volatile markets, causing prices to swing wildly like a pendulum. In such an environment, it's crucial to stay nimble.
The VIX, the market's go-to fear gauge, is again flashing warning signals. The break above 20 most certainly heralds a systematic house cleaning of risk assets, suggesting we may soon see more plunge protection trades layered across various markets. The uptick in the VIX is causing severe indigestion in global markets.
If stocks continue their downward spiral, rules-based traders could unwind significant positions. Commodity Trading Advisors (CTAs) are still set to sell off US stocks even if the market stages a comeback. Should the bears take charge and the slide extends through the first whole trading week of August, momentum traders could withdraw as much as $200 billion from global stocks. This potential exodus underscores the precariousness of the current market landscape. ( $200 billion is via Goldman Sachs FICC and Equities Futures Markets Strats team)
Speaking of systematic-driven meltdowns, Tokyo got walloped by $600 billion that vanished into thin air over the past 48 hours, during the worst two-day plunge since the infamous 3/11 earthquake aftermath. The Topix took a nosedive of over 6% on Friday as traders scrambled to adjust to a newly hawkish Bank of Japan (relatively speaking) and a Fed teetering on falling behind the curve.
To put it in perspective, this two-session drop was more brutal than any seen in the chaotic early days of the pandemic. On Friday, the Nikkei suffered its worst session since March 2020, dropping nearly 13.5% over the past three weeks, with the Topix close behind at a 12.8% loss.
What a dramatic fall from grace for Japanese shares! Earlier this year, they were popping champagne, celebrating their first all-time highs since 1989, buoyed by the belief that the deflation demon had finally been vanquished. Fast forward a few months, and that euphoria feels like a distant dream.
This week, the Bank of Japan decided to play the villain, hiking rates and signalling more to come while sketching a plan to halve its bond-buying spree. This was the BoJ's second rate hike of the year, and the markets didn’t see it coming.
The hawkish twist was like throwing gasoline on an already-on-fire yen rally. The speed and scale of the selloff in Japanese equities suggested a full-on stampede, with everyone heading for the exits and no one sticking around to buy. The resulting volatility triggered the algos into a sell-all scenario, worsening a bad situation.
The stronger Yen clobbered exporters, and tech stocks took a hit after Amazon’s revenue miss in the US set the stage for another round of mega-cap volatility. The market’s dramatic turn of events has left investors reeling, proving once again that in the world of finance, it’s always wise to expect the unexpected.
In short, the once-celebrated rally has hit a massive speed bump, and it looks like it might be a bumpy ride ahead. Fasten your seatbelts, traders – the market rollercoaster isn't over yet!
THE FOREX VIEW
As regular readers know, since July 11, I've been a seller in all scenarios—flat, up, or down tape—or at least buying plunge protection. A big chunk of that has been through the Yen, which I saw as the most straightforward trade ahead of the Bank of Japan in a market that misread entirely the politically stronger yen tea leaves.
While I had a boatload of gold on board, we cut half after the NFP and then got removed (stop profit order) through $2450/oz. I still like gold higher, but that's what my burgeoning stash of local baht-weight wafers is for. The paper trade is for speculation. One issue with being long paper gold in a gnarly risk-off environment is the need for traders to sell off profitable trades to cover unprofitable losses. In the case of a broader meltdown through August, which I peg at 60:40, there's a good chance traders will sell gold to cover margin calls.
On the FX side, Canada typically catches a cold when the US sneezes. Hence, we bought USDCAD, eyeing a potential test of the 1.4000 area. I sold EURUSD just above 1.0900 simply because betting on a weak currency during the US and a possible global recessionary beatdown could end in tears. I’ll revisit this trade next week when I'm teeing off at the first hole at Banyan in Hua Hin at my regular 6:00 AM.
I've taken back a good chunk of long Yen positions this morning (still long), but FX trades are easy to revisit. I tend to move out of trades I've been in for a while once they start gaining popularity. Plus, I don't want to be glued to my mobile phone in August.
So, we now have small FX trades on board, as I find it disingenuous to recommend a trade without entering it myself.
NUTS & BOLTS
July brought a reality check to the job market with a notable slowdown in job growth and a two-tenths of a percent uptick in the unemployment rate to 4.3%, triggering the Sahm Rule recession indicator. Add a jaw-dropping drop in the ISM Manufacturing Index to a dismal 46.8, a second straight month of falling construction spending, and a bigger-than-expected surge in initial jobless claims last week. It’s no wonder everyone’s on high alert for a sharper economic slowdown and more Fed rate cuts than anyone had pencilled in.
The market’s mood swings were on full display: traders were popping champagne on Wednesday over the Fed hinting at a potential rate cut in September, but by Thursday, the party was over. The S&P 500 handed back all its Wednesday gains and then some, now sitting about 6% below its July 16 peak. Meanwhile, the NASDAQ decided to outdo everyone with a 10% plunge since July 11.
Though looser than pre-Great Recession norms at a positive 0.56, the Bloomberg Financial Conditions Index has tightened considerably over the last month, hitting its lowest point since interest rates spiked in November 2023. It’s like the market suddenly realized it had eaten too much at the rate-cut buffet and is now dealing with a severe case of economic indigestion
While most economic indicators aren’t flashing red just yet, the signs start to point towards a slowdown in July. U.S. economic surprises are trending strongly to the downside, like a sports team on a losing streak. While not as grim as a few weeks ago, the Bloomberg Economic Surprise Index is still the most pessimistic it's been since 2022.
The ISM Manufacturing Index flagged significant declines in manufacturing production, new orders, and employment last month, coupled with an unwelcome increase in the prices paid component. However, it's essential to keep things in perspective. The overall index level of 46.8 isn't far off from the 2023 annual average of 47.1In other words, manufacturing has come full circle, reversing the rebound in the ISM Manufacturing index we saw in the first quarter of this year and bringing the sector right back to square one. (Scott Anderson, Ph.D.Chief U.S. Economist and Managing Director
Economics at BMO )
The bottom line is that it's still too early to forecast an impending recession. While the economic clouds are gathering, it’s not time to break out the storm gear.
CHART OF THE WEEK
It's a repeat from above; the VIX takes no prisoners.
TWEET OF THE WEEK
If the Fed is forced to make their first rate cut of the cycle a jumbo 50 basis points, it's basically their way of saying, "Oops, we goofed!" But this tweet from Albert Edwards is a better way to contextualize it.
RUNNING UPDATE
Besides realizing I have a minuscule hairline crack on my ribs—making sleeping a real pain—running has been surprisingly good this week, all things considered. We're in the midst of the rainy season, so I'm basically playing weather forecaster, trying to time my runs during windows when the odds of a lightning strike are low. While running in tropical rain is amazing, heading out when the odds of lightning are present is a no-go.
I managed one great long run this week—my park run, covering 15 km. Despite the curve jumps and dodging sidewalk craters on the 5 km jaunt to get there, the Somdet Phra Srinakarin Park run epitomizes a serene 8 km morning run. The final sidewalk loop back home is an easy 2 km sail.
I also did my usual 5 km tempo check, hitting the 3rd fastest time of the year, which is exactly where I want to be ahead of the December marathon season. It's 3:30 AM, and the rain has stopped, so I’m off for a 15-20 km run.
SONG OF THE WEEK
Led Zeppelin was a big help this week on both the long and tempo runs. Fingers crossed, they show up on today’s long run in random selection mode on Spotify. Oddly, I wasn’t a big fan when I was a kid, but I started to really like them as I got older. They're definitely a band that aged like a fine vintage. At least in my musical wine rack.