With stocks, bonds, and crypto tumbling, inflation spiraling out of control, and months of Federal Reserve tightening, it feels like anything that can go wrong in the financial markets can. Panic is in the air.
For traders looking for a silver lining, that’s about the best that can be said.
The S&P 500 is down almost 9% in three days, a painful stretch that has left virtually nothing unscathed, including energy stocks, the best-performing group of the year.
Bond selling has accelerated, with 10-year Treasury yields hitting their highest since 2011 and two-year rates at their highest since the financial crisis.
The cost of protecting investment-grade bonds from default soared, and an ETF tracking the sector plunged to its lowest level since March 2020.
Can it get any worse? Yes, history is full of examples of premature bullishness. Backgrounds turn out to be wrong, dates get uglier and things that seemed cheap turn out to be expensive a day later. For folks who find seller exhaustion a useful guiding star, it’s fair to say that the process is underway.
There is no telling how long it will take – although there are indicators that have helped in the past.
“It’s always difficult,” said Nancy Tengler, CEO and chief investment officer of Laffer Tengler Investments, of distinguishing between the beginning and end of a market sell-off. “Typically, one of the things you look for is panic selling,” she said.
“The question is how much more pain is there and how long will it last?”
The slowdown flame is being fanned by the consensus that sky-high inflation will require a more aggressive response from the Fed to bring it under control, which in turn will drag US economic growth downward.
Money markets are now seeing the final central bank rate at 4% for the first time and are pricing it in until the middle of next year. Certain areas of the market are anticipating the Fed going to major extremes this week, with some banks not ruling out a possible 100 basis point hike.
At 3,750 points, the S&P 500 is now trading at just over 15 times its estimated 2023 earnings, at the bottom of its valuation range over the past decade. In better times, that could inspire confidence that an end to selling was within reach.
With emotions currently dominating the markets, there is precious little to rely on in a bull market.
Strategists and chartists say on behalf of the retail investor cohort they are watching for high volume, a surge in the Cboe’s volatility gauge, patchy stock moves and capitulation.
Stocks will have a hard time recovering without the VIX hitting 40, a level Evercore ISI strategist, Julian Emanuel, says it will mean a “cathartic flush-out.” The volatility gauge rose above 34 on Monday.
Trading volume on U.S. stock exchanges topped 15 billion shares on Monday, up 3 billion from the year-to-date average.
JonesTrading’s Dave Lutz, meanwhile, is keeping a “surrender list”. He sees more panic and watches if the VIX hits 38, a level it reached in February.
The put-to-call ratio on the S&P 500 has approached its highs for the year, another sign that a potential bear market washout is imminent. On the other hand, a measure of the index’s relative strength is 32, above the level that would indicate an oversold condition.
Monday’s session also marked a “big drawdown” day with extreme breadth, Lutz said. All but five stocks in the benchmark index fell. Retail investors, on the other hand, “are starting to suffer enough wounds. They definitely get scared,” he said.
Selling earlier in the week was relentless. Energy, the best-performing sector of the year, lost more than 5%, its worst session in more than a month.
All the nervousness about the Fed’s moves has revived recession warnings from economists, who see the Fed raising rates at a pace that won’t allow the economy to dodge a downturn. Morgan Stanley’s chief executive said he sees the risk of a US recession at around 50%.
“This is going to be a recession,” said Victoria Greene, chief investment officer at G Squared Private Wealth. “It’s funny that we still have recession deniers. I don’t see how it can’t drag itself into a recession just because of the drastic steps the Fed has to take.
This year’s bear market reached its destination faster than average. It typically takes the S&P 500 244 days to fall 20% from its peak, according to Bespoke Investment Group.
The current one only lasted 161 days. And in more than half of the 14 bear markets since World War II, the index bottomed within two months of breaking through the 20% threshold.
According to Lori Calvasina, head of US equity strategy at RBC Capital Markets, the S&P 500’s break below 3,850 on Monday could just be the beginning of even steeper selling that could take the index to 3,200, or more than 30% off January’s highs.
That’s equivalent to “the average peak-to-trough S&P 500 recession loss since the 1930s,” she wrote in a report.
Calvasina also notes that such a decline would be analogous to the Covid sell-off in early 2020, “leading us to believe that this is a reasonable place to start thinking about how deep the S&P 500 might fall in a recession loss this time around.”
Elsewhere, Saira Malik, CIO at Nuveen, sees opportunities in growth stocks. The cohort suffered losses five times larger than its value peers in May.
Growth and technology price-to-earnings multiples may be looking more ‘encouraging’ and while inflation moderation is elusive, a plateau may be in sight soon. “Tough times for growth stocks continue, but we see bright spots amidst the darkness,” she wrote.
While it may be true that traders want to see the VIX higher than it currently is before they can shout a capitulation, according to Art Hogan, chief market strategist at National, it’s difficult to come up with a clear definition of what a washout event really looks like Securities.
“We’re probably closer to the surrender point today than we were a month ago,” Hogan said in an interview. “Unfortunately, in the real world, you can’t set strict guidelines for what panic and capitulation selling looks like.”
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