No matter how badly we want to answer the “Why?” question, it’s almost never a good idea to attribute a given day’s price action to a single, proximate cause.
While it’s all too easy to point fingers at readily identifiable macro catalysts (e.g., Evergrande or generic “inflation worries”), it’s never that simple. Especially not in modern markets, where mechanical flows play an outsized role. Indeed, on many days, the price action is the story.
To be clear, there’s no question that the worst day for US equities since May (Tuesday) was a product of rising bond yields. As Nomura put it Wednesday, “the selloff in rates [was] at the core of the equities volatility spasm.”
Underscoring the point in terms that are perhaps more amenable to a wider audience than those I often employ, Wells Fargo’s Chris Harvey wrote that,
Tuesday’s duration selloff is exactly what one should have expected. Many growthier names were going up in the summer not due to fundamentals, in our view, but rather because rates were going down. Now that rates are going up, these stocks are reversing course, completing the loop.
At the same time, though, the accompanying increase in realized vol (which is also a product of other recent down days) triggered systematic deleveraging, exacerbating the move. And the duration selloff was itself exacerbated by hedging flows.
There’s more than a little ambiguity around what, precisely, triggered the bond rout in the first place. You’ll recall that it played out on a delay last week, accelerating not after the September FOMC, but rather the next morning (in the US) after gilts reacted to a hawkish BOE statement, which itself came on the heels of a Norges Bank rate hike. The quest to explain Tuesday’s equity selloff leads us back to belabored efforts to explain the bond rout.
“Higher bond yields post last week’s more hawkish FOMC, along with higher oil prices, stabilization in high frequency economic indicators, and evidence that the latest COVID surge in the US has peaked, have pressured the Growth trade and bolstered the Value and Small Cap trades,” RBC’s Lori Calvasina said Wednesday, calling the rotation and shift in leadership “yet another hurdle for the S&P 500 given the index’s heavy bias towards secular growth.”
Note that the Nasdaq 100 is on track for its worst month since last September, when a summer melt-up turbocharged by retail investors’ options activity and a Japanese whale finally buckled under its own weight (figure below).
In any event, it doesn’t help that the political environment in the US is becoming still more fraught by the day. As a quick aside, new readers should note that you actually have to read Heisenberg Report in order to get my take on current events. You can’t simply scan the article titles. I understand why the media and bloggers use the headlines they do — they’re desperate for web traffic and ad revenue, because they have bills to pay. And why journalists are instructed to never bury the lede — it’s poor form, especially in America, land of the 15-second attention span.
For me, though, there’s simply no point in penning boilerplate commentary the gist of which can be captured in just a few words or just a few sentences. That’s anathema to me and contrary to the site’s raison d’être. So, for example, if you want my take on the debt ceiling and this week’s Beltway wrangling, you’ll need to read “Dysfunction Junction,” “To The Brink. For The Sheer Hell Of It” and Wednesday’s “Maybe America Wasn’t Such A Good Idea After All.” If that seems like a lot of effort to you, I’m sorry. But I’m not going to be publishing some slapdash chart of bill yields spiking with a toddler-esque, crayon-style annotation in 150-point font accompanied by a couple of sentence fragments. I want real readers. And unlike some folks, I don’t need the page views. In fact, I sometimes write titles with the express intent of not landing in Google search results.
Of course, for media outlets that prefer the tabloid style (and that’s basically all financial media outlets, or at least when it comes to their daily markets coverage), this week was a veritable godsend. Tuesday’s Senate hearing featured no shortage of headline friendly soundbites, including a drop-dead date from Janet Yellen on the debt ceiling and Elizabeth Warren calling Jerome Powell a “dangerous man.” (I like Warren, but as discussed at length here, the shtick is getting old. And make no mistake, it is part shtick.)
To what extent did sundry soundbites contribute to Tuesday’s equity rout? Relatedly, are investors concerned about Jerome Powell’s job? Wells’s Harvey addressed those questions in the same note cited here at the outset.
“It is debatable how much the stock-trading debacle damages Powell’s re-appointment odds, but it clearly hurts the optics and the likelihood of a near term re-appointment,” Harvey wrote, adding that “this has created some uncertainty, at least at the margin—and could not have come at a worse time for equities, in our view, given the existing pressures from the bond market and Capitol Hill.”
As for Yellen’s remarks on the debt ceiling, Harvey noted that “the consensus was late October/early November, so the earlier ‘X date’ surprised the market and helped catalyze the selloff.”
Just as Harvey added “at the margin” to his assessment of the uncertainty created by the proximity of the Fed’s trading scandal to Joe Biden’s decision on re-appointing Powell, I’d add it to Yellen’s debt ceiling remarks too. That is: It “helped catalyze the selloff at the margin.” The wheels were already in motion. The action in rates knee-capped mega-tech and once accelerant flows (both in equities and rates) kicked in, it spiraled. Yellen could have said October 28 or October 23 or some other date and it wouldn’t have mattered.
“Until now, it seems Congress has been lulled into a false sense of security by a rising equity market” Harvey went on to say. “Yellen’s comments and subsequent market reaction quickly ended that.”
I, for one, doubt lawmakers committed to perpetuating acrimony were swayed by a one-day swoon in equities. But I do agree with Harvey’s assessment of the two parties.
“The GOP believes the party in control of the government will take the political hit [and while] we see their point, public opinion often is difficult to predict,” he said of Republicans, before noting that “Democrats’ strategy is unclear to us.”
“Especially not in modern markets, where mechanical flows play an outsized role. Indeed, on many days, the price action is the story.”
This is such an important point. Every up and coming trader should ponder that. As should we old timers, though it’s a harder sell for those who continue to believe that there is some set of immutable rules, laws and relationships which dictate market action.
Thanks!
I used to think there were fundamental reasons for market moves on a daily or weekly basis. No more. Sentiment and flows drive markets over the short to intermediate term. If you get those right, you are generally ok for that time horizon. Fundamentals kick in on a much longer time frame.
@RIA – I went through the same process. It was very liberating when I finally came to the conclusion that P/E ratios are simply thermometers showing demand which means that flows are the most important thing to focus on.
Though I’ll confess that I do ponder relative valuations when comparing companies within an industry group. So old-fashioned, eh?
Good article!
@derek, I still think there is idiosyncratic information to be found by comparing a company to its close comps and its price action to theirs. Anyway, as long as enough investors think it matters, then it will.