Markets Rethink Popular Trades Amid Economic Uncertainty

 

The assumptions driving this year’s global financial markets are being rapidly rethought.

In bond and currency markets, investors are redeploying money amid doubts about the US economy, leading to speculation that the Federal Reserve may need to cut interest rates faster or deeper than planned. A weakening American consumer, evidenced by disappointing corporate earnings, is driving this shift.

Simultaneously, stockholders are growing skeptical about the immediate payoff of technology companies' massive investments in artificial intelligence. As a result, investors have been dumping shares of big winners such as Nvidia Corp and Broadcom Inc.

Copper and other industrial metals are reversing recent gains due to China’s slowdown and concerns over the US and tech sectors.

“It does seem that an unwinding has begun of popular trades that brought valuations to stupid levels,” Louis-Vincent Gave, CEO of Gavekal Research, wrote in a note to clients Thursday.

At Apollo Global Management, chief economist Torsten Slok noted, “If the economy starts slowing down, the speed of the slowdown becomes essential. A faster slowdown would have negative implications for earnings and increase the probability of a selloff in stock markets and credit markets.”

Notable Market Moves and Changing Assumptions:

Government Bonds

• The bleaker global growth outlook is bolstering wagers on rate cuts. Investors are snapping up short-dated securities, concerned that monetary policy is too tight.
• On Thursday, the yield on the two-year US Treasury note traded just 12 basis points above the 10-year, indicating a narrowing inversion.
• Traders see about 30 basis points of easing by September, suggesting a 20% chance of a supersized cut. Over 70 basis points of cuts are anticipated through 2024.
• The yen, which suffered under US monetary tightening, has rallied around 6% from a recent low.

Stock Markets

• US and European equity markets had been buoyed by the belief that inflation was under control and that the Fed would ease monetary policy.
• The Stoxx Europe 600 Index and S&P 500 saw significant gains, with the latter setting a record as recently as July 16.
• Now, many investors believe the Fed is falling behind the curve, with inflation quieting and the economy weakening. China is already easing monetary policy amid its economic slump.
• Almost a third of S&P 500 companies have reported second-quarter results, with only 43% beating revenue expectations, the lowest in five years.
• The AI investment frenzy has lost its luster, particularly after Alphabet Inc's heavy spending with little immediate revenue impact. The Nasdaq 100 Index has dropped nearly 8% from its July 10 record.

Metals

• Pessimism about demand and the tech industry is affecting the metals market.
• Copper has fallen below the US$9,000-a-tonne threshold and is down about a fifth since mid-May.
• Investors are now concerned about rising inventories and weak conditions in the Chinese spot market.
• Tin and aluminum have also declined.

“In the perennial tussle between fear and greed, the former has seized the upper hand as a raft of consensus positions have suffered losses this week. It all represents a collective trip to the pain cave, one of those periodic episodes when positioning is just about the only fundamental that matters as investment risk gets reduced across the board,” said Bloomberg macro strategist Cameron Crise.