Volatility Strikes

#116: A short-term unwind and long-term concerns.

In weeks like these, it behooves me to write in simple and direct terms. How did we get here and where are we going?

The turbulence in the equity markets hasn’t been a product of hidden risk, but rather the big stinking obvious risks. Big tech was crowded, thematic beneficiaries jumped the shark, small-caps lagged, growth was slowing, rate cuts were coming, volatility was compressed. This column has covered all of these factors over the past several months, just as most financial publications have. The hard part was knowing when the music would stop.

In many cases, it is hard to pin market moves on a specific catalyst, but in this case it seems pretty clear. The June Consumer Price Index report, released on July 11th set the wheels in motion.

The negative inflation data solidified the expectation of rate cuts, sparking a historic rotation out of mega-cap tech into small-cap laggards as investors absorbed the bright side of rate cuts. The dimmer side of rate-cuts — the implication of a weakened and price-sensitive consumer — came later, taking down stocks both large and small. Macroeconomic concerns led to sudden rush to protection and a collapse in overseas markets led to the biggest squeeze in volatility since March 2020.

Yet after four weeks of chaotic market action, the net results are modest. The bloody month in the Nasdaq, down 11% since CPI, merely unwound the prior month’s gains. Similarly the S&P 500’s close of 5,319 yesterday is unchanged since late May. The Russell 2000 survived a wild round trip and remains modestly positive over the period.

A passive investor awakening from a ten-week coma would find their positions unchanged, and would be much better rested.

But even if a zoom-out provides some sanguine perspective, there is no doubt that mood has shifted. The easy trades — giddy memes, trend chasing and vol-selling — have bitten back. The unemployment rate has now risen 0.6% over the year while job growth and wage gains continue to slow. Even as the market found some footing this week, bearish economic sentiment has emerged from hibernation.

This week we cover:

• The Unwind

• The Volatility Squeeze

• Macroeconomic Risks