One week / one topic: Panic mode, activated

What happened?

Pretty much wherever you look, we are witnessing very large risk-off price moves:

• Within equities, the Nasdaq 100 (white) has lost 15% since the mid-July highs and Japanese stocks (blue) are down 25% from the peak

• Government bonds have soared, with US 2yr yields (red) down a massive ~100 bps over just 5 weeks

• The Yen (green) has also rallied 12% vs the Dollar, for a massive reversal of a very popular carry trade

Markets then have abruptly shifted from ‘everything is fine’ to ‘we need emergency rate cuts!’.

Is it all overdone, of just the beginning of something much larger?

Can we spot opportunities to add risk, or – conversely – protect portfolios before it’s too late?

Our observations

• Fundamentals: In short order, manufacturing, corporate earnings and employment have all disappointed. The latter – long identified as the canary in the coalmine – suddenly looks fragile, with both initial and jobless claims now visibly above pre-pandemic trends.

• Price action: Looking at z-scores, recent price moves are indeed very large. Perhaps most interestingly, this is the first ‘deflationary shock scare’ since March 2023 (SVB) but this time it feels much more broad-based. Notably, government bonds are (finally) acting as portfolio insurance once again.

• Investor beliefs: Market commentary about possible Fed emergency rate cuts feels very premature. That said, rates are sending a clear recessionary impulse – overdone perhaps, but also likely still at odds with current equities levels?

So what?

Over the last few weeks, we had closed our Chinese equities position, trimmed US Tech exposure and added to US 30yr government bonds.

(As usual – when a trade works – in hindsight you wish you had done more…)

As we are still in the middle of wild market moves – for example, Nikkei futures fell 12% and then rallied 9% all in the space of 6 hours – we strive to balance caution with our core stance of ‘patient opportunism’.

Next, upcoming data releases could provide relief by assuaging growth concerns, and/or policymakers could also signal a clear willingness to ‘smooth the path’ from here.

That said – should we not get either development – markets might push further from here and test new lows in equities / bond yields.

Should we get ‘there’, even more powerful feedback loops will likely kick in.

Sure, economic ‘fundamentals’ may look little different vs last week – but markets pricing a much higher likelihood of a recessionary outlook would make it more likely to happen.