(Bloomberg) -- For years, Wall Street had it all figured out. If the stock rally is in danger, pile into the Big Tech safety trade. Scared the economy is slowing down? The Federal Reserve has your back.
Now money managers can no longer bet on these market saviors as the most tumultuous week of the year across assets trashes their once-reliable trading playbooks.
With Friday’s poor labor data underscoring the risk of an economic downturn ahead, the bond market flashed an unambiguous warning that Jerome Powell’s restrictive monetary stance now risks a policy error. It comes just as the great AI boom of 2024 shudders after high-profile earnings disappointments and fresh fears that the investment splurge has yet to pay off for much of Corporate America.
Mighty Tech, whose biggest names staged a sizzling rally through June, plunged into a correction, erasing about $3 trillion of value in less than a month. A long-sleepy gauge of trader angst spiked to the highest in two years. Yields on 10-year Treasury yields tumbled by the most since 2008.
It’s just one volatile week in a year of epic risk taking and the Fed is keen not to over-react to one month of data. Yet money managers are now suddenly hedging everything from the risk of a mild stock downturn to a full-blown crisis. Fund managers, who’ve minted billions of dollars in easy profits riding the hottest trends in mega-cap equities, are taking a hit.
“We will all grapple with the risk that the Fed might be too late and/or 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 are acknowledging the very real danger that the economy may be slipping into below-trend growth.”
A once-unimaginable half-point interest rate cut in September has fast become the baseline for a cohort of Wall Street banks suddenly convinced Powell has waited too long to act. July’s jobs report had one of the weakest showings since the pandemic, just as US manufacturing activity contracted by most in eight months.
The Nasdaq 100 tumbled 3% in its fourth week of losses while the S&P 500 closed the week down 2%. Yields on 10-year Treasuries tumbled nearly 40 basis points this week and an exchange-traded fund tracking Treasuries staged its strongest rally since 2020. Wall Street’s “fear gauge” — the VIX — soared toward its highest level since 2022 at one point in Friday trading, approaching 30.
One way to contextualize the upheaval is a Wall Street indicator plotting how quickly sentiment is shifting from one minute to the next. The VVIX, or the volatility of the volatility index, soared by about 40 points this week, a stretch that included one 3% rally and two 2%-plus tumbles in the Nasdaq 100. It now sits at the highest since March 2022 when stocks were in the beginning of their biggest annual swoon since the financial crisis.
Of course, while the moves represent the biggest market eruption of 2024, they’re far from without recent precedent, with Treasuries and tech companies posting epic losses just two years ago. Betting against Powell and the Magnificent 7 have been a costly mistake for traders in episodes past, and history is replete with summer stock selloffs that later unwound.
“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.”
If nothing else, the recent swings trace a pattern where weakness in equities is offset by gains in bonds, a relationship that bolsters diversification in a way that was absent for long stretches of the past two years. An ETF tracking Treasuries rose nearly 6% on the week. The inverse relationship has rarely been more pronounced than it was this week.
Still, the options market shows that demand for protection is real. The price of tail-risk hedges that pay out in a big stock crash – perhaps as much as 30% — rose to the highest level since May 2023.
Fueling the moves are fear Powell erred Wednesday in signaling a rate cut isn’t in the cards before September. Traders are now pricing a half-point cut at the Fed meeting in September as the most likely outcome. Dovish comments from Powell helped extend a stock rally Wednesday that was summarily unwound Thursday and Friday as concerning economic data convinced traders he wasn’t dovish enough.
“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 where the economy is today. Certainly not consistent to where inflation is today.”
For a better part of a decade, investors have taken solace in reliable tech earnings, which have proven an antidote to a host of market ills. Now though, they are suddenly a source of anxiety. Intel Corp. shares slid the most since at least 1982 after the chipmaker signaled it’s ill-equipped to win the AI race. Amazon.com Inc. tumbled after it told investors that profits for now will take a backseat to heavy AI spending.
“The dam is breaking, at least for now,” said Mike Bailey, director of research at FBB Capital Partners. “Investors might be dialing down tech earnings growth if we hit a recession. Why pay a huge multiple for a tech stock with slower growth?”
--With assistance from Emily Graffeo, Katie Greifeld, Sydney Maki and Liz Capo McCormick.
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