A Global Panic or Normal Drawdown? — Evening Brief – 08.05.24
The selling pressure that disrupted global stock markets towards the end of last week intensified on Monday, resulting in key U.S. indices declining by 2% to 3% amid growing concerns of a slowing economy.
The Nasdaq fell into correction territory as investors worried about lofty valuations and large cash outlays for artificial intelligence investments. Even before Monday’s price action, the Philadelphia Semiconductor Index was already in a bear market, having fallen 22% from its peak. Investors are preparing for additional days of volatility as the VIX soared to 65 on Monday, its highest level since COVID when it peaked just over 80.
However, while U.S. stocks experienced significant declines, Japan’s main stock index, the Nikkei 225, had its worst-ever daily drop on Monday, shedding 4,451.28 points compared to the previous day’s closing price. This sharp decline was caused by panic selling driven by concerns about a potential U.S. recession and the strength of the yen.
The sell-off was the largest ever in history and worse than the Black Monday crash of October 1987, when it lost 3,836.48 points. The average closed down 12.4% to 31,458.42.
The Bank of Japan began to raise interest rates last week, largely to stem the steep fall in the yen, as many other developed central banks have been slashing interest rates and the Federal Reserve set to follow in September, which has already wiped out trillions in value and is having knock-on effects across global markets of various asset types.
The yen has been particularly affected by the reversal of carry trades, which involved investors borrowing at reduced rates in Japan to finance the acquisition of higher-yielding assets in other countries. The USD/JPY has lost a record 20 figures, falling from 162 a few weeks ago to 142 on Monday, a drop of over 3% since Friday.
“With yen carry trades now being unwound quickly, not only has the Japanese currency notably broken its depreciation trend against all major units, but risk assets that those trades were financed with are also being sold off,” wrote Asymmetric Advisors strategist Amir Anvarzadeh, in a note to clients.
It’s a tech debacle for good reason: the leverage provided by the carry trade directly benefited many of the best-performing stocks, and as a result all the Magnificent 7 names are under pressure.
“In these sorts of scenarios, investors need to be careful,” said Ben Barringer, an analyst at Quilter Cheviot. “When sentiment begins to sour, the falls become more extreme than perhaps they should be. The next few weeks are likely to be a volatile one for tech stocks as this new environment plays out.”
The gap between U.S. stocks and bonds is narrowing as a result of the U.S. equity selloff. Equities were outperforming U.S. bonds (BND) by approximately 18 percentage points year-to-date. The substantial margin has shrunk significantly to about seven percentage points as of Monday, due to a flight-to-quality. The yield curve is bull steepening, as well, resulting in a dis-inversion of the US 2s/10s yield spread.
The U.S. economy’s health has become a primary concern following the release of weaker-than-expected payrolls and a rise in the unemployment rate on Friday, which triggered a closely monitored recession indicator and fueled concerns that the Federal Reserve has not acted swiftly enough to reduce interest rates.