US Stock Market Bottom: Recession Fears

• News
• 2024-10-19

On Monday, global risk assets were on edge, with Asian markets opening low and continuing to decline. Popular positions from yen carry trades to cryptocurrencies were sold off, and the drying up of liquidity triggered circuit breakers in several Asian markets during the trading session.

The panic then spread to Europe, with the pan-European Stoxx 600 index falling to a six-month low, and U.S. stocks fell further before the market opened, with Nasdaq futures experiencing a maximum drop of over 6%. The market began to trade on the expectation of an emergency rate cut under the recession scenario, while the "de-foaming" under high valuations is still ongoing.

Under what circumstances would there be an emergency rate cut?

Affected by negative earnings reports and poor economic data, last week the U.S. Nasdaq index fell by 10% for the first time since the beginning of 2022, entering a correction range.

Subsequently, the post-market plunge in U.S. stock futures also put pressure on the Asian markets that opened first, with the technology sectors in Japan and South Korea under collective pressure, and the South Korean Kosdaq index fell by more than 11%. The Nikkei 225 index plummeted by more than 4800 points, setting a historical record for the largest single-day decline. Stock markets in Thailand and India fell by more than 3%. The European and U.S. stock markets that opened later also experienced a brief sharp decline.

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As usual, financial market turmoil has led investors to bet that central banks will be forced to cut interest rates ahead of schedule. Fund rate futures indicate that the probability of the Federal Reserve cutting rates by 50 basis points in September is over 80%, with the possibility of up to 5 rate cuts for the year. At the same time, the market expects the European Central Bank and the Bank of England to cut rates by 74 basis points and 47 basis points respectively within the year, and is pricing in another rate hike by the Bank of Japan in October.

There were even rumors on social media that the Federal Reserve would hold an emergency meeting on the 5th to discuss the impact of financial market turmoil. It turned out that this might just be a wishful thinking. Chicago Fed Chairman Goolsbee continued to downplay concerns about a recession that day but said that the Federal Reserve needs to recognize changes in the environment to avoid rates being too restrictive.

BK Asset Management macro strategist Boris Schlossberg said in an interview with reporters, "Can we say that the U.S. is entering a recession now? Obviously, it's not enough. Looking at the level of consumer spending and the state of the labor market, it can only be said that the economic expansion will slow down and does not have the specific conditions for a cliff-like recession." However, he believes that if U.S. stocks continue to plummet and the market faces liquidity risks, the Federal Reserve may take preemptive measures to prevent the risk from spilling over into the real economy, just like in March 2020.

It is worth mentioning that the proposer of the "Sahm Rule" also believes that the economy has not fallen into a recession. Claudia Sahm, Chief Economist at New Century Advisors, an investment management company, said in an email: "We are not in a recession now, but the momentum is heading in that direction. Employment data may overstate the weakness in the labor market caused by the abnormal changes in labor supply due to the pandemic and immigration." She added: "The 'Sahm Rule' is currently sending the correct warning signals about the cooling of the labor market, but the noise is too loud."

Institutions are adjusting their forecasts for the U.S. economy. Goldman Sachs has raised the possibility of a recession within 12 months by 10 percentage points to 25%. "If the August employment report is as weak as the July report, then there may be a 50 basis point rate cut in September."JPMorgan Chase believes there is a 50% chance of a U.S. economic recession. The bank's Chief Economist, Michael Feroli, stated: "The Federal Reserve now appears to be significantly behind the curve, and we anticipate a 50 basis point rate cut at the September meeting, followed by another 50 basis point cut in November. In fact, there is a case for an emergency rate cut during the meeting, although Federal Reserve officials may worry that such a move could be (misunderstood)."

In the foreign exchange market, expectations of rate cuts have led to a steady decline in the U.S. Dollar Index, and the rise of the Japanese yen has further squeezed carry trades. The U.S. Dollar against the Japanese yen once plummeted by more than 3% during the session, falling back below the 142 psychological level, and the Euro against the Japanese yen also saw its largest intraday drop exceeding 2%. The Swiss Franc has also become a major beneficiary of the safe-haven rush, with the U.S. Dollar against the Euro falling to a six-month low, testing support at 0.85.

After the panic trading and bubble squeeze, the adjustment may continue if a recession ultimately becomes a reality. According to statistics from Truist Advisors, since World War II, the S&P 500 has averaged a 29% decline during economic recessions.

The latest earnings report from Berkshire Hathaway, owned by legendary investor and "Oracle of Omaha" Warren Buffett, has also raised market concerns: the group sold about half of its stake in Apple and pushed its cash reserves to an unprecedented $277 billion in the second quarter.

Prior to this, disappointing earnings from tech giants such as Amazon, Google, and Intel have already ignited investor concerns about potentially overvalued stocks. Travis, portfolio manager at Intrepid Capital, said: "Over the weekend, people began to reassess what the risks are and whether they are in the right position."

The CBOE Volatility Index (VIX), which measures the volatility of the U.S. stock market, surged by more than 100% during the session, hitting a four-year high. Daniel Krieter, a strategist at BMO Capital Markets, stated, "The panic in the financial market (the shocking speculation about an emergency rate cut by the Federal Reserve proves this) reinforces itself in the financial market, especially in August when liquidity is scarce."

It should be noted that although U.S. stock valuations have declined in the recent sell-off, they are still high by historical standards. According to data from the London Stock Exchange Group (LSEG), the S&P 500's 12-month forward price-to-earnings ratio was 20.8 times last week, slightly below the mid-July high of 21.7 times, but still far above the historical average of 15.7 times. If more bad news comes, this could lead to further stock selling.

Art Hogan, Chief Market Strategist at B. Riley Wealth, said: "In the face of pressure, investors will use anything as an excuse to sell." He expects that the absence of major economic data before the release of the Consumer Price Report on August 14th may keep the market in a state of tension.

Charles Schwab mentioned in its market outlook that U.S. stocks exhibit seasonal weakness in August/September, with investor confidence being hit and the market potentially becoming more sensitive to any signs of economic weakness. Although from the perspective of the VIX, a technical rebound after selling may occur at any time, it is obviously unrealistic to confirm the market's bottom right now.