Some Wall Street bets are falling amid market volatility and AI disappointments

Wall Street’s once-trustworthy strategies have faltered as volatile markets and AI disappointments have sapped investor confidence. The bond market is signaling the risk of a Fed policy error, underscoring economic uncertainty and prompting investors to hedge against potential downside.

A volatile week rocks Wall Street as Big Tech bets fail and economic fears grow

Wall Street has had it all figured out for years. Investing in Big Tech security trades is a good idea if a stock market rally is in danger. Are you worried about a potential economic slowdown? The Federal Reserve is on your side.

Fund managers can no longer rely on these market saviors as the most volatile week of the year for assets has destroyed their once-trustworthy trading manuals.

The bond market has been clearly warning that Jerome Powell’s tight monetary stance is now at risk of a policy error. Weak jobs data released on Aug. 2 underscored the risk of an economic slowdown, according to Bloomberg. It comes as a significant 2024 AI expansion is starting to waver on high-profile earnings disappointments and new concerns that the investment frenzy has yet to yield meaningful gains for much of corporate America.

In less than a month, the tech industry’s biggest names, which surged in June, have seen a correction, wiping out about $3 trillion in value. The biggest gain in two years came in a long-dormant gauge of trader anxiety. The yield on the 10-year Treasury note fell the most since 2008.

The Federal Reserve has been cautious about overreacting to a single month of data because it’s just one volatile week in a year of unprecedented risk-taking. But fund managers are now suddenly hedging against a range of risks, including a modest stock market decline and a full-blown crisis. The hottest trends in large-cap stocks have generated billions of dollars in hassle-free profits for fund managers who are now suffering the setback.

“We’re all going to have to face 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, a portfolio manager at JPMorgan Asset Management. “Markets are looking ahead and seeing the danger that the economy could fall below trend growth.”

A group of Wall Street institutions that had previously been unconvinced that Powell had waited too long to act have adopted a half-percentage-point rate cut in September as their standard. U.S. manufacturing activity shrank by the most in eight months, and the July jobs report was one of the weakest since the pandemic.

Nasdaq and S&P 500 see sharp declines as market volatility rises to 2022 levels

The Nasdaq 100 fell 3% for a fourth week of losses, while the S&P 500 ended the week down 2%. The yield on the 10-year Treasury note fell nearly 40 basis points this week, and an ETF tracking Treasury bonds posted its biggest gain since 2020. In trading on Aug. 2, the VIX, Wall Street’s “fear gauge,” surged to its highest level since 2022, approaching 30.

One way to contextualize the turmoil is with Wall Street’s indicator, which captures the speed at which sentiment changes from minute to minute. This week, the volatility index, or VVIX, posted a 40-point gain, consisting of a 3% gain and two declines of more than 2% in the Nasdaq 100. It was the highest since March 2022, when stocks were at the beginning of their biggest annual decline since the financial crisis.

Naturally, these moves are the most significant market breakout of 2024; however, they are not unprecedented, as Treasuries and tech companies suffered significant losses just two years ago. Traders have made costly mistakes in the past by betting against Powell and the Magnificent 7, and history is full of summer stock sell-offs that then reversed.

“August is a terrible, terrible month for the stock market. And I know that because it’s cut off almost every summer vacation I’ve taken over the last 20 years,” said Jay Hatfield, founder of Infrastructure Capital Management. “The market is trading like we’re in a major recession. Our thesis is that we have a normal seasonal panic, and then we get more data on the economy and we realize it’s not going down, it’s slowing down.”

Bond gains offset stock declines as market braces for potential Fed rate cut

At the very least, the recent volatility shows a pattern in which bonds are rising and stocks are falling. That relationship has been absent for the past two years and has added to the diversification. This week, an exchange-traded fund that tracks Treasurys is up nearly 6%. The inverse relationship has rarely been more evident than this week.

Still, the options market is showing real demand for protection. The price of tail risk hedges, designed to provide payouts if stocks fall significantly, has hit its highest point since May 2023, with potential for 30% upside.

The moves are fueled by concerns that Powell made a mistake on July 31, indicating that a rate cut is imminent in September. Traders are predicting the Fed will implement a half-point cut at its September meeting. Powell’s dovish remarks on July 31 prompted an abrupt reversal in an extended stock rally, as traders believed Powell was not sufficiently dovish on economic data.

“They’re lagging,” Rick Rieder, global fixed income chief investment officer at BlackRock Inc. and head of global allocation investing, told Bloomberg Television. “This price of interest rates is not consistent with the current economic environment. It’s certainly not consistent with current inflation.”

For nearly a decade, investors have sought refuge in steady tech profits as a panacea for various market woes. But suddenly, they have become a source of concern. The chipmaker’s admission that it is ill-equipped to win the AI ​​race sent Intel Corp. shares into their biggest slump since 1982. Amazon.com Inc. saw its shares fall after announcing that it would, for now, prioritize AI spending over profits.

“The dam is bursting, at least for now,” said Mike Bailey, director of research at FBB Capital Partners. “Investors could squeeze tech earnings growth if a recession hits. Why pay a huge multiple for slower-growth tech stocks?”