No Stimulus, No Peace as Stocks End Two-Month Snooze With Plungeby
Recent Fed, ECB comments have traders skeptical of more easing
S&P 500 falls most since June as bond proxies lead plunge
After two months in which even a 50-point move in the Dow Jones Industrial Average was reason for excitement, investors were shaken out of their slumber as central bankers signaled reluctance to extend stimulus and sent U.S. stocks to their worst week since February.
Damage was worst in the final session, when Boston Federal Reserve President Eric Rosengren warned against waiting too long to raise interest rates. Selling built after European Central Bank President Mario Draghi downplayed the need for more measures to boost growth a day earlier. When it was over, the S&P 500 Index was down 2.3 percent to 2,127.81 on the week, with Friday’s plunge wiping out a slight gain over the first three days.
Among the many beacons of complacency that went dark Friday was a trading range in the S&P 500 that had stood as the tightest ever recorded, a stretch of calm in which no move took the benchmark index above 2,190.15 or below 2,157.03 for 40 days. The gauge closed at a two-month low that sent it below its 50-day moving average for the first time since June, while the CBOE Volatility Index, a measure of price turbulence, climbed above 17 for the first time in 50 sessions.
The end came suddenly for investors who spent the summer pondering the meaning of improving economic data and its influence on Fed policy. In fed funds futures markets, traders briefly pushed bets for a rate increase this month to 38 percent, before lowering them to 30 percent. Odds fell to 22 percent on Wednesday following a string of weaker-than-forecast reports on hiring, manufacturing and services activity.
A selloff such as Friday’s has long been predicted by bears, who saw it as a fitting end to a stretch of unprecedented complacency that lasted most of the summer. It was confirmation to them that however strong economic data may have looked in July and August, gains in global equities are being maintained by central bank intervention.
“There’s no question people have been relaxed for the past month or two,” said John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York. “But the market is now showing some disappointment in recent central bank commentary. They’ve given the market enough of a reason to get nervous again. It certainly has my attention, and I’m clearly not the only one.”
The Dow finished the week down 406.51 points to 18,085.45 after closing just under 150 points from an all-time high last week. The Nasdaq Composite Index fell 2.4 percent for the five days, even after reaching a record on Wednesday.
The selling wasn’t limited to stocks, as the central-bank hawkishness sent Treasuries tumbling to the lowest since June. That sparked a rout in equities that serve as bond proxies, with selling Friday harshest in phone and power companies, the two groups that yield the most in the S&P 500 at 4.6 and 3.5 percent, respectively. Shares plunged at least 3.4 percent, the most for either group since at least February 2015. It marked a reversal for the pair, which led the market higher through July 15 with gains of more than 20 percent.
Real-estate investment trusts, coveted in recent months for their high payouts as Treasury yields languished near historic lows, dropped the most since August 2015. An exchange-traded fund that tracks the group saw trading volume spike 13 times the three-month average. A rising U.S. dollar sent miners in the S&P 500 tumbling 3.6 percent in the week, the biggest rout since January.
Friday’s selloff may have been worsened by investors who built up positions under the cover of low volatility, according to Nikolaos Panigirtzoglou, global market strategist in the multi-asset allocation team of JPMorgan Chase & Co. In particular, hedge funds that use levels of market turbulence as an input in buy signals were particularly susceptible, he wrote in a client note on Friday.
“The stock market has been quite dependent on central bank liquidity in recent years,” Matt Maley, an equity strategist in New York at Miller Tabak & Co LLC, wrote in a note to clients on Friday. “Global central banks have become a lot less accommodative over the past few weeks. This makes the upside potential for the market quite limited.”
The lockstep moves across assets can be seen in a Credit Suisse Group AG gauge tracking price relationships in equities, credit, currencies and commodities, which sits at the highest since at least 2008. Such an increase in correlations is fodder for skeptics who look at declining U.S. earnings and rising valuations and argue that the only explanation for record highs in U.S. stocks this summer is Fed policy.
The S&P 500’s exit from its historically tight trading range sent the measure of market turbulence known as the VIX soaring. The index rose 46 percent for the week, its biggest five-day increase since January. At 17.50 as of Friday’s close, the so-called fear gauge has rallied 54 percent since falling to a two-year low of 11.34 in August.
Nine of the S&P 500’s 10 major groups declined more than 1.6 percent this week, with material and consumer staple shares falling the most. Energy was the only industry to increase, adding 0.7 percent as crude oil climbed 3.6 percent.
While financial shares lost 2.2 percent for the week, they still stand to be one of the biggest beneficiaries of an increase in odds for a rate hike, according to Yousef Abbasi of JonesTrading Institutional Services LLC. Prior to this week, the group rose to 2016 highs as the implied probability for a rise at September’s Fed meeting more than doubled to 32 percent.
“People leaning pretty heavily on the notion we might see a September move,” said Abbasi, a global market strategist at JonesTrading. “You’re going to see a rotation within the equity market and that’s going to be people getting more comfortable owning asset managers and financial companies.”