Wall Street's Safe Bets Collapse Amid Volatile Market and AI Disappointments

Wall Street's once-reliable strategies faltered as volatile markets and AI disappointments eroded investor confidence. The bond market signals a Federal Reserve policy error risk, highlighting economic uncertainty and driving investors to hedge against potential downturns.

Volatile Week Shakes Wall Street as Big Tech Bets Fail and Economic Fears Rise

Wall Street had it all figured out for years. Investing in the Big Tech safety trade is advisable if the stock rally is at risk. Are you concerned about the potential slowdown in the economy? The Federal Reserve is on your side.

Money managers can no longer rely on these market saviors as the most volatile week of the year across assets has destroyed their once-reliable trading playbooks.

The bond market clearly warned that Jerome Powell's restrictive monetary posture is now at risk of a policy error. According to Bloomberg, the poor labor data released on August 2 underscored the risk of an economic downturn. It co-occurs as the significant AI surge of 2024 is beginning to sway in response to high-profile earnings disappointments and new concerns that the investment splurge has not yet yielded significant returns for a substantial portion of Corporate America.

In less than a month, the most prominent names in technology, which had witnessed a ferocious rally throughout June, experienced a correction, resulting in the loss of approximately $3 trillion in value. The most significant increase in two years was observed in a long-sleepy gauge of trader distress. The 10-year Treasury yields experienced their most significant decline since 2008.

The Federal Reserve is cautious in avoiding overreacting to a single month of data, as it is merely one volatile week in a year of unprecedented risk-taking. However, money managers are now abruptly hedging against various risks, including a moderate stock market decline and a full-blown crisis. The hottest trends in mega-cap equities have resulted in billions of dollars in effortless profits for fund managers, who are now suffering a setback.

“We will all grapple with the risk that the Fed might be too late and too slow in cutting rates, and all asset classes should reflect that,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “Markets are forward-looking and acknowledge the danger that the economy may slip into below-trend growth.”

A cohort of Wall Street institutions previously unconvinced that Powell had waited too long to act has adopted a half-point interest rate cut in September as their standard. US manufacturing activity contracted by the most in eight months, and July's employment report was one of the weakest since the pandemic.

Nasdaq and S&P 500 See Steep Declines as Market Volatility Surges to 2022 Levels

The Nasdaq 100 experienced a 3% decline in its fourth week of losses, while the S&P 500 ended the week with a 2% decline. This week, the yields on 10-year Treasuries experienced a nearly 40 basis point decline, and an exchange-traded fund that monitors Treasuries experienced its most significant increase since 2020. During August 2 trading, the VIX, Wall Street's "fear gauge," surged to its highest level since 2022, approaching 30.

One method of contextualizing the turmoil is a Wall Street indicator that illustrates the rate at which sentiment changes from one minute to the next. This week, the volatility index, or VVIX, experienced a 40-point increase, consisting of a 3% rally and two 2%-plus declines in the Nasdaq 100. It has been at its highest since March 2022, when equities were at the outset of their most significant annual decline since the financial crisis.

Naturally, the movements are the most significant market eruption in 2024; however, they are not unprecedented, as Treasuries and technology companies experienced significant losses just two years ago. In the past, traders have made costly mistakes by betting against Powell and the Magnificent 7, and history is replete with summer stock selloffs that subsequently reversed.

“August is a horrible, horrible month for the stock market. And the reason I know that is it has interrupted almost every one of my summer vacations over the last 20 years,” said Jay Hatfield, founder of Infrastructure Capital Management. “The market is trading like we’re going to have a significant recession. Our thesis is that we have the normal seasonal freak-out and then we get more data on the economy and realize it’s not plunging, it’s just slowing.”

Bond Surge Balances Equity Decline as Market Braces for Potential Fed Rate Cut

At the very least, the most recent fluctuations demonstrate a pattern in which the increase in bonds counterbalances the decline in equities. This relationship has been absent over the past two years and has enhanced diversification. On the week, an exchange-traded fund that monitors Treasury securities experienced a nearly 6% increase. The inverse relationship has been rarely more pronounced than it was this week.

Nevertheless, the options market demonstrates a genuine demand for protection. The price of tail-risk hedges, designed to provide payouts in the event of a significant stock collapse, has reached its highest point since May 2023, with the potential for a 30% increase.

The movements are driven by concerns that Powell made an error on July 31, indicating that a rate cut is imminent in September. Traders anticipate the Fed will implement a half-point reduction at its September meeting. Powell's dovish remarks on July 31 contributed to the abruptly reversed extension of a stock rally because traders were persuaded that Powell was not sufficiently dovish regarding economic data.

“They are behind the curve,” Rick Rieder, BlackRock Inc.’s chief investment officer of global fixed income and head of the global allocation investment team, told Bloomberg Television. “This price for rates is not consistent with where the economy is today. Certainly not consistent with where inflation is today.”

For nearly a decade, investors have sought refuge in consistent technological earnings, which have served as a remedy for various market-related issues. However, they have abruptly become a source of anxiety. The chipmaker's admission that it is inadequately prepared to prevail in the AI race resulted in the most significant decline in Intel Corp. shares since 1982. Amazon.com Inc. experienced a decrease in stock value after its announcement that it will prioritize AI expenditures over profits for the time being.

“The dam is breaking, at least for now,” said Mike Bailey, director of research at FBB Capital Partners.“Investors might dial down tech earnings growth if we hit a recession. Why pay a huge multiple for a tech stock with slower growth?”