David Solomon, the chief executive of Goldman Sachs, is not normally found walking the bank’s trading floor. Monday, however, was an abnormal day for many on Wall Street.
Solomon headed down to the fourth floor of the bank’s Tribeca headquarters as its traders grappled with one of the most chaotic days of market action in recent years.
He was not the only senior figure stalking the front office. Ashok Varadhan, the co-head of Goldman’s global banking and markets business, was spending much of the day in contact with the team that traded securities tied to the Vix — the volatility index ubiquitously known as “Wall Street’s fear gauge”.
Upstairs, the group’s wealth management practice was hosting a call for more than 5,000 investors answering questions on the likelihood of a recession, how weak US economic data had caught markets off-guard, and the hypothetical market impact of a war in Iran.
Downtown, officials and traders on the floor at the New York Stock Exchange were discussing whether circuit breakers would force a marketwide trading halt for the first time since the outbreak of the coronavirus pandemic.
By the end of the day, almost 90 per cent of stocks on the MSCI All-Country World Index (ACWI) had fallen in an indiscriminate global sell-off. Nvidia — the chipmaker that had single-handedly driven almost a third of the US stock market’s gains in the first half of 2024 — shed around $400bn in market value in the space of a few minutes, before adding most of it back in the next few hours.
Yet within a few days, most of the turmoil seemed to have been forgotten. By Thursday evening the ACWI and S&P were both down less than 1 per cent for the week.
On their own, the whipsaw swings of the past week-and-a-half say more about the psychology and structure of modern markets than they do about any fundamental shift in the economic or financial outlook.
But the moves did not happen in a vacuum. For some market veterans, the real aberration was an extended post-pandemic period of steady market moves. When this week’s events are combined with other cracks that began emerging over the past month, there are signs of a longer-term shift that could lead to a period of increased volatility after years of unusual calm.
“The market was so certain there would be a soft landing in the US, that there was complacency that any other outcomes were even possible,” says Joe Davis, the global chief economist at Vanguard. “There was so much concentration, too many investors and market participants all having the same view of the world . . . and that view was really warm and fuzzy.”
Now, he says, there has been a “repricing of that thinking”.
Most observers believe the sheer scale of the moves over the past 10 days was out of proportion to the initial triggers.
The immediate spark for the sell-off was a pair of economic updates on the first two days of August — a survey of manufacturing companies, followed by official figures on the state of the labour market — that heightened concerns that the US economy was heading for recession and the Federal Reserve was moving too slowly to cut interest rates.
The jobs data in particular was well short of expectations, showing the US economy had added just 114,000 new jobs in July compared with expectations of around 175,000, but the figure was not even the worst result of the year.
An initial sell-off spiralled out of control when Asian markets had a chance to respond on Monday, as the bad news about the US economy combined with concerns about the impact of rising interest rates in Japan and a stronger yen. Huge numbers of investors have taken advantage of Japan’s low rates in recent years to borrow cheaply in yen and invest in assets overseas, including in large US tech stocks — the so-called “yen carry trade”.
The Tokyo stock price index suffered its sharpest fall in almost four decades, and the Vix “fear gauge” peaked at 65, a level only hit or surpassed a handful of times this century — including in the early days of the coronavirus pandemic in 2020, and at the height of the global financial crisis in 2008. A Vix of 65 implies investors expect the S&P 500 to swing an average of 4 per cent a day over the next month.
“At its peak, the ferocity of the selling was very reminiscent of the 2008 global financial crisis, but without the systemic risk fears,” says Bruce Kirk, Japan equity strategist at Goldman Sachs. “The breadth and depth of the sell-off appeared to be driven a lot more by extremely concentrated positioning coming up against very tight risk limits.”
Market makers say a lack of supply of derivatives to hedge against price movements in the early hours of Monday morning contributed to the sharp moves in the Vix, but in most areas the biggest driver was hordes of investors moving in the same direction, rather than a structural problem.
“There’s nothing wrong with the plumbing, the market makers were there, you just haven’t had the yin and yang of different views going against each other. Everyone is seeing the market the same way and responding to the data of the day,” says Patrick Murphy, head of NYSE market making at GTS, the trading firm.
The growth of certain investment strategies can make sudden momentum shifts more likely. Three brokers say multi-manager hedge funds — which have multiple portfolio managers or “pods” running different strategies — had been a key driver of the recent growth in Japanese markets. These funds are structured to be closed down or have positions liquidated very quickly when markets turn against them.
“The amount of money that is sitting outside of the regulated system, they can really move markets,” says one senior Wall Street bank executive.
Japanese stocks had also been boosted by domestic retail traders using high amounts of leverage; when those positions began losing value, margin calls for more collateral led to additional forced selling.
In the US, funds that use algorithms to follow market trends were particularly caught out by the string of disappointing economic data. Société Générale’s CTA index, which tracks the performance of 20 of the largest such funds, fell 4.5 per cent in the first week of this month, adding to selling pressure as funds scrambled to cover short positions.
When funds that invest in momentum reverse course you can expect a “sharp reaction”, says Shep Perkins, the chief investment officer for equities for Putnam Investments, an asset manager owned by Franklin Templeton.
“There’s a saying: stability breeds fragility,” he adds. “The stability led to complacency and the market was testing folks to say, ‘hey do you know what you own?’”
A rebound on Thursday highlighted the lack of fundamental clarity in what had come before.
Less than a week after the disappointing payrolls data, a separate — and traditionally less important — update on the US jobs market encouraged the S&P 500 to its best day since November 2022.
“The market is so fascinated with what is the latest data point,” says Jim Tierney, a portfolio manager at AllianceBernstein. “The ties between fundamentals and day-to-day stock price moves, I’m not sure they’ve ever been more disconnected than they are today.”
But there have been some signs of a more meaningful shift in the background. Pressure is building on multiple fronts including the US economy, corporate earnings, global interest rates and politics.
Growth in the US is clearly trending downward, and the second-quarter earnings season has been dominated by warnings about consumers cutting back on spending.
Investors had also been voicing concerns about stretched stock market valuations for months, particularly in the technology sector. Big gains for the largest tech companies, driven by enthusiasm about artificial intelligence, had helped prop up the wider US stock market, but most have so far shown little return on the hundreds of billions they have invested.
“The bloom is off the AI rose a little bit,” Putnam’s Perkins says. “Even Nvidia, the poster child for AI, announced a delay in a new chip. Given how much excitement was underpinning Nvidia, a delay like that matters.”
Investors were caught off guard by the Bank of Japan’s interest rate rise on July 31, but that also tied into a longer-term trend, with the BoJ having finally ended its negative interest rate policy a few months earlier.
Meanwhile global politics has grown more uncertain, with tensions flaring up again in the Middle East, and the entry of Kamala Harris as the Democratic candidate making the US presidential race more unpredictable.
Each change may have been manageable on its own, but the cumulative impact is beginning to have an effect. Stocks had been unusually calm since a brief sell-off last October, but this week would mark the fourth consecutive week of declines for the S&P 500, and the Vix had been slowly trending higher even before this week’s spike.
“There has been a decent amount of new information — when you start to stack four or five concerning things, it’s not unreasonable for the market to have done what it did” since mid-July, Tierney adds.
The shakeout caused by the unwinding of the yen carry trade in particular could be seen as one of the last gasps of the pandemic era of easy returns facilitated by easy money.
The beginning of the Federal Reserve’s rate hikes in 2022 was seen as the end of an era during which low rates dampened volatility and encouraged investments in risk assets, but in a globalised market, investors need not be bound by the rates of their home country.
With the last holdout central bank finally — gradually — moving away from its low rate policy, another long-term volatility dampener has been removed.
Investors are still trying to disentangle the ultimate impact of all these different factors, but few expect a return to the steady gains of the past 18 months. “From a trader’s perspective, we feel volatility is back in the market,” says GTS’s Murphy.
Markets have identified a host of potential set-pieces that could cause sharp swings in the weeks to come, according to analysis by Citibank. Options markets have priced in daily moves in the S&P 500 of around 1.5 per cent to coincide with the release of inflation data, the next payrolls update, the annual meeting of global central bankers in Jackson Hole, Wyoming, and Nvidia’s second-quarter results.
In a historical context, it was the almost two years without a 3 per cent daily drop in the S&P 500 that was more unusual than Monday’s price action in the US.
“You see these events every once in a while. It was a reminder that when there is consensus thinking, the market can turn on its head in a very short amount of time,” says David Giroux, a chief investment officer and head of investment strategy at T Rowe Price.
Even after a pullback from the high the market hit in early July, he points out that the S&P 500 is still up around 9 per cent year to date. “It only [feels] horrible because we’ve had a really good run in the marketplace and only had modest corrections and people got complacent,” he adds. “At the start of the year people would have happily signed up for 9 per cent.”
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