Global stocks have defied expectations of a decline and continued to rise, causing concerns of complacency among investors. However, recent events have shown that these fears may be justified. Factors such as growth concerns in Europe, shifts in Asian monetary policy, and nervousness over rising bond yields and the US government’s credit rating have led to one of the worst weekly sell-offs in stocks so far this year. While the declines were moderate, it was still the worst week since March. This sudden volatility contrasts sharply with the optimistic predictions made just a week ago, where the consensus was that central banks were close to finishing interest rate hikes and the Federal Reserve was on track to achieve a soft landing. However, it seems that this optimism may have been premature.
At the start of the year, most big investment houses and bank analysts had a negative or neutral outlook on US stocks. They believed that the aggressive campaign of Fed interest rate rises would inevitably harm companies, households, and growth. The inverted yield curve, with low long-term US government bond yields in relation to shorter maturities, was seen as a clear sign of an impending recession. In hindsight, it appears that the weight of this consensus was overwhelming, and concerns over Fed excesses had already been reflected in last year’s drop in stocks. However, by the halfway point of 2023, US and global stocks had made significant gains, with a scorching rally in tech stocks leading the way. Even underperformers like Europe and Japan saw gains. This positive outlook on inflation, particularly in the US, has been pushing expectations that interest rates are at or close to their peak, leading to the belief that bond yields will stall or fall. As a result, investors have been more willing to buy riskier assets.
Some of the biggest pessimists are now starting to question their bearish views. Hedge funds with negative bets on stocks are capitulating, and even previously bearish analysts like Morgan Stanley’s Mike Wilson admit that they were wrong this year. The derivatives market also reflects the positive consensus, with a record-low price for hedging against a decline in the S&P 500. However, this upbeat environment may be overdone, and some investors are starting to see the need for buying cheap protection.
Recent events have punctured the optimistic atmosphere. Fitch Ratings cut the US government’s credit rating, causing a loss of confidence. The US also increased its debt issuance target, driving the 10-year Treasury yield to a nine-month high. Additionally, the Bank of Japan’s policy change relaxed its cap on local bond yields, attracting Japanese investors away from other markets. These factors have contributed to increased volatility and uncertainty in the market.
Overall, while the market has experienced a great run, there are concerns about a potential correction and the need for a soft landing. Economic data releases and summer trading volumes add to the volatility. Despite this, experts remain confident that stocks are in a new bull market. However, it’s important to acknowledge that a soft landing is still based on economic realities, and equity markets may be starting to heed economists’ warnings.
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