Yesterday, CNBC was able to roll out its “MARKETS IN TURMOIL” package, and honestly, it felt appropriate. Stocks went into a sudden and mysteriously violent tailspin on Thursday.
After rising 3 per cent on Wednesday after Federal Reserve chair Jay Powell indicated that the central bank wasn’t contemplating raising rates by more than 50 basis points at a time, the S&P 500 then tanked 3.6 per cent on Thursday.
It is interesting to see that various analysts, investment managers and financial journalists have been better able to say what happened yesterday — and present myriad arguments for what it means — than exactly why it happened.
Our colleagues Robert Armstrong and Ethan Wu did a great job exploring some of the potential explanations in Unhedged, but here is what some other people are saying.
What happened?
Tellingly, the pain yesterday was most intense in US technology stocks, and especially its frothiest corners, deepening a sell-off that started when the Fed first made a hawkish pivot last autumn.
The Nasdaq tumbled almost 5 per cent on Thursday, completely unravelling Wednesday’s 3 per cent gain. This follows a similar pattern in late April, when another 3 per cent plus one-day gain came immediately undone the following day.
Sharp reversals like this are actually deeply unusual, as Bespoke Investment Group’s George Pearkes highlighted in an overnight note.
Aside from one occurrence in 2020, you have to go back to the financial crisis of 2008 and the dotcom bubble bursting in 2000-01, to see such reversals. And there have only been seven since at least 1971 — two of which have now happened in the last two weeks.
Elsewhere, US Treasury yields rose across the curve, but not uniformly in magnitude. While two-year US government bond yields rose 8 basis points to 2.71 per cent by the end of Thursday, the yield on the 10-year note jumped by 14 bps to 3.06 per cent, and the 30-year Treasury yield climbed about 16 bps to 3.16 per cent.
According to Jay Barry, managing director for interest rate strategy at JPMorgan, there have only been six instances in the past decade during which 30-year bond yields rose more than they did on Thursday.
Why did it happen?
Mike Zigmont, head of trading and research at Harvest Volatility, said some investors had feared the Fed was about to get “obscenely aggressive” before Powell used his press conference to scotch speculation that a 0.75 percentage point rise might be on the cards further down the line.
Once those worries had been banished there was a “huge” bullish move which in turn triggered a “ton of intraday momentum” on Wednesday, Zigmont said.
April had been a disastrous month for equities and the market was ready to bounce, he added, but it “shouldn’t be rallying 3 per cent on what was basically a pep talk [from Powell]”. Thursday’s car crash was the “response to that response”, he argues.
It’s like a runaway train: if you’re long and you start to see your gains from yesterday melting away, you’re gonna start to panic and start to dump and say, ‘we’re in a bear market’. [Wednesday and Thursday] were evidence that the world is very sensitive, emotions are yo-yoing like crazy.”
[Wednesday and Thursday] were digestion sessions — even though the Fed hit the bullseye on expectations for policy adjustment, there’s so much nervousness about that people don’t really know how to process the huge chunk of information they got hit with. Group dynamics start to set in. In a normal market, bears and bulls fight it out. If you get a rally, you get a noisy rally, it’s never a square step up or down. That’s not happening right now.
By the end of Wednesday, Powell’s “dovish hike” had sent both the dollar and bond yields lower, equities higher and tightened credit spreads, essentially easing financial conditions, said Huw Roberts, head of analytics at Quant Insight. “On Thursday, the market realised that this is completely the opposite of what the Fed is trying to engineer; the one consistency we’ve had from Powell is that financial conditions have to tighten.”
One intriguing explanation for why the Fed reappraisal sell-off became so violent is the dynamics surrounding two big leveraged exchange traded funds, known as TQQQ and SQQQ.
TQQQ, or ProShares UltraPro QQQ to give it its full name, is a triple-leveraged $13bn version of Invesco’s QQQ, a monster $169bn ETF that tracks the Nasdaq 100 index. SQQQ is a $2.9bn “inverse” version of QQQ that attempts to do three times the inverse of the Nasdaq.
Some analysts suspect the hedging of these leveraged ETFs (TQQQ plummeted more than 14 per cent) may have exacerbated the Nasdaq’s drop. From JPMorgan’s Mike Gormley. Apologies for the Greek.
Into the close, leveraged ETFs (think TQQQ, SQQQ) had to sell $15bn and SPX theoretical short gamma of ~$55bn likely led to $15-20bn per 1% (so ~$45-50bn) of selling on the immediate move lower. We stabilised into the close which is likely due to pre-positioning on leveraged ETF selling as it was well publicised and SPX gamma hedging getting out of the way earlier (we traded higher into the last 30 minutes).
Gormley reckons the trigger for the sudden reversal was the Bank of England raising interest rates on Thursday despite forecasting a recession later this year, and/or the US announcing it would refill its emergency oil reserve.
Taking that together, it is clear systematic selling, short gamma positioning mixed with poor market depth led to the exacerbated move lower in equities. When looking at potential triggers, our candidates are the BOE rate hike where updated MPR pointed to stagflation risks or oil spiking on the headline that Biden would start buying to refill the SPR. . You can see the timing of the cable collapse and spike in oil is around when e-minis collapsed, with oil timing right around the move.
What does it mean?
Barclays’ equity analysts said that the sell-off signalled that investors are finally waking up to what it calls “a new paradigm” for financial markets, where they seek to “sell the rally” rather than “buy the dip” — after a decade where the latter reigned supreme.
Following years of unlimited and free money, markets and economies are now facing a new paradigm. Learning to live with tighter liquidity will not be a smooth process, in our opinion, although froth has already been taken away from some parts of financial markets. Investors should keep their seatbelt on.
The problem seems to be that investors seem unusually uncertain of the path forward. Nick Colas of DataTrek Research highlighted how the Vix volatility index didn’t go higher than 33 points on Thursday — below even March’s peak — despite the S&P 500 suffering its 15th worst day of the past decade.
Markets can’t seem to decide if they want the Band Aid of easy monetary policy ripped off quickly or only peeled off slowly. While markets may stabilise soon — the last two post-Fed meeting periods have seen rallies — today’s action tells us investors should proceed with extreme caution.
On Twitter — where one of us spends far too much time — a lot of wags were thrilled to see CNBC’s “markets in turmoil” programming, given its tendency to bottom-tick routs.
Did CNBC’s “Markets In Turmoil” special mark the bottom for stocks?
— Michael A. Gayed, CFA (@leadlagreport) May 6, 2022
There was a glimmer of good news on Friday, with US non-farm payrolls increasing by 428,000 in April, above economists’ expectations. But the S&P 500 and the Nasdaq Composite shrugged and were down 0.6 per cent and 0.7 per cent respectively at pixel time.
Tell us what you think about it all in the comments below.