Global Markets Go on Wild Ride in Week Marked by Forced Selling
It started, innocently enough, in markets, when high-flying tech stocks started giving back gains that nearly all of Wall Street was convinced had gone too far.
Roughly a month into a trauma that expanded this week to encompass everything from emerging-country currencies to Japanese shares — before defusing almost as fast — a lot of people worried about the economy are hoping markets are where it will stay.
A signature fact of the worst turbulence of 2024 remains how much of it is confined to excesses wrought by traders. Speculators exploiting an ever-weakening yen got chased out of cross-border wagers. Quants who’d been ringing up gains for months suffered a comeuppance. Popular options bets premised on calm briefly blew up.
In short, while economic fears lit the match that fueled the selloff’s loudest bursts, a daisy chain of leverage drove a slew of market reversals that muddy the potential recessionary message from slumping stocks — to everyone from retail day traders to Jerome Powell, who looks poised to lower rates in September. With a slew of asset classes and sectors not yet screaming economic angst, one bullish mantra is beginning to emerge from the noise: Buy the dip.
“It is a healthy correction for now. Crowded positions and panic resulted in accelerated selloff,” said Vineer Bhansali, founder of the Newport Beach, California-based asset manager Longtail Alpha. “The momentum trade made everyone very long a concentrated set of positions, and exit liquidity is dismal.”
For investors resisting the urge to sell, it may be the strongest plank in the bull case. And while anyone saying it’s all an overreaction must answer to the steep drop in bond yields — as close to an unambiguous sign that the economy is in trouble as markets ever send — those who stuck it out were rewarded as volatility receded at week’s end.
“When you get these violent moves, the market always overshoots, and that’s exactly what happened,” said Michael de Pass, global head of rates trading at Citadel Securities. “It was an overshoot driven by a bond market that had a lot of room to rally given where current fed funds levels are.”
One thing’s for sure: despite reversing just as fast this week – equities and bonds both – the great August swoon of 2024 has become front-page news, providing ammo in the U.S. presidential race and ramming into the popular consciousness fears of a US recession or monetary-policy error. Should it resume, the potential exists for serious global tumult, sweeping up carry traders in Tokyo, emerging-market investors in Mexico and volatility professionals in New York.
Panicked moves were the theme of the week, particularly Monday, when Japan’s Topix tanked 12 per cent, the Cboe Volatility Index surged 42 points in the space of a few hours and losses in the S&P 500 at one point surpassed four per cent. All at once, global traders who’d been riding risky assets to gains for months lost their nerve. Weakening US labor data convinced many the Fed had waited too long to cut rates, leading them to dump stocks after U.S. Treasury yields staged the biggest one-week slide since 2008 last week.
Especially harsh for professional investors was disruption of a popular strategy where money borrowed in the Japanese currency is used to fund purchases of higher-yielding assets elsewhere — the so-called carry trade — which shuddered as the yen appreciated for five straight weeks. The amount of money involved is disputed — estimates range from tens of billions of dollars into the trillions — but its unwinding was particularly pronounced in Asia, where an MSCI index tracking the region swooned six per cent to start the week.
Elsewhere among the pro class, systematic funds that use volatility as a signal to buy or sell assets rushed to exit equities and load up on bonds and cash. So tranquil had markets been in the runup to July that one category of volatility-controlled funds had pushed its allocation to equities to 110 per cent. Now it’s about 50 per cent, marking the sharpest drop since the onset of the pandemic. Quant trend followers were another group thought to have been squeezed out of the market by preprogrammed rules.
“Systematic investors who scale their leverage on volatility would have had to reduce their exposure,” said Jitesh Kumar, a cross-asset derivatives strategist at Societe Generale SA. “Summer is not the most liquid period of the year, and volatility-based flow triggers are likely to have contributed to the selloff.”
Still, almost as quickly as it blew up, volatility eased. After bouncing Tuesday, the S&P 500 staged its biggest rally since 2022 on Thursday and managed to finish its most tumultuous week since 2022 virtually unchanged. Bond yields rose over three straight days and the VIX dropped back toward 20 after rising above 65 at the height of the maelstrom.
Knee-jerk rebounds are common and not always trustworthy. But a narrative emerged as the week progressed that rather than a result of sure signs the economy was doomed, market tensions mostly reflected forced selling, with the potential to abate once investors caught their breath. Thursday’s stock surge was spurred by a report suggesting anxiety about the labor market was overstated, and the promise of rate cuts helped assuage the economic dread.
Futures markets are pricing in around a percentage point of Fed easing by the end of the year, including a likely quarter-point cut next month as Wall Street banks have been rushing to up their projections. Although last Friday’s jobs data showed weaker hiring, the monthly rate remains above 100,000 and some pundits wrote off the higher unemployment rate as an aberration related to weather.
On the earnings front, tech champions Alphabet Inc., Amazon.com Inc. and Tesla Inc. all saw their shares slide after disappointing results. Yet the broader picture remains sound. As of Friday, analysts put S&P 500 profit growth at just over 14 per cent in 2025 and 11.8 per cent in 2026.
“The base case remains a soft landing, and stock markets should see further gains in the coming months. Concerns around earnings are overblown,” said Max Kettner, chief multi-asset strategist at HSBC Holdings Plc. “We think this was an overreaction of risk assets.”
A notable aspect of the last few weeks is their resemblance to the market meltdowns that have whipped up since the Fed began its campaign to tame inflation two years ago. While a month-long bout of intermittently extreme volatility shocked investors who had been breezing along in a straight-up market, charts show at least six separate instances of identically rough sledding as recently as 2022, when the S&P 500 plunged.
Through it all, fund clients have remained unconvinced anything awful is happening. Investors sent nearly US$10 billion to equity funds, including a $3.3 billion inflow to tech funds, in the week through Wednesday, according to a Bank of America note citing EPFR Global data.
“The initial panic episode was excessive,” said Gerry Fowler, UBS’s head of European equity and global derivative strategy. “The market will slowly regain its confidence, but we won’t see volatility fully retraced back to very low levels and the market may struggle to make confident new highs.”
