Don’t call it a selloff. Seriously. Do yourself a favor.
Earlier this week, a lot of intelligent people (and even more not-so-intelligent ones) suggested Jerome Powell should convene an emergency Fed meeting on the way to delivering an inter-meeting rate cut.
The rationale for such calls went as follows. The Fed should’ve cut at the July FOMC meeting in order to preempt additional softening in the US labor market and help prepare the runway for a soft landing. Subsequent data (jobless claims, ISM manufacturing and, ultimately, US payrolls) confirmed the economy’s faltering, underscoring the case for a cut. Then Japanese equities collapsed by the most since 1987, a rout triggered in part by ongoing yen strength which is itself attributable in part to the perception of flagging US growth.
Two days later, such calls (for an emergency rate cut) seem laughable. Japanese equities are back to where they were on Friday (albeit still down markedly from record highs) and US shares were just 6.5% from their July 16 peak through midday Wednesday, although they faded to close lower.
Here’s the thing: There was never a proper “selloff” in the US in the first place. There certainly was in Japan, but the S&P never made it into correction territory. Have a look at the simple figure below, from Goldman’s David Kostin.
The “selloff” on Wall Street didn’t even match the median annual peak-to-trough decline looking back four decades.
“Note that while the drawdown has been sharp, it has barely reached the magnitude of the market decline in a typical year,” Kostin remarked.
So, no. An emergency Fed cut wasn’t called for. And yes, it’s perfectly ok to question the judgement of anyone who demanded such a cut, but not necessarily traders’ judgement for betting on it: After all, traders are just wagering on what they think might happen, not necessarily what they think should happen.
As to whether this (non)selloff was a dip worth buying, Kostin noted that investors do “typically profit” from buying the index down 5%.
The figures above are your “if past is precedent” charts.
Kostin spelled it out. “Since 1980, an investor buying the S&P 5% below its recent high would have generated a median return of 6% over the subsequent three months, enjoying a positive return in 84% of episodes,” he wrote, adding that “corrections of 10% have also been attractive buying opportunities more often than not, but with weaker hit rates of outperformance than following 5% drawdowns.”
If you’re wondering why the hit rate’s lower for corrections versus pullbacks, the answer’s straightforward: Stocks fall 5% for all kinds of reasons. 10% corrections, by contrast, are more likely to coincide with a material deterioration in the fundamentals, a shock or both.
I had a conversation with a well-known economist who is on the talking head circuit on Monday. I am generally dovish on monetary policy and more so today, since I think real rates are very elevated. He is not nearly as dovish as I am. I told him the Fed should cut rates intermeeting only if the credit markets froze. Monday corporate borrowers postponed deals, but had not reached a level of frozen, at least not yet from what I could see. I did tell him in my view, that the FOMC was late and should be looking to cut 50 bps in September, and that Powell would be smart to allude to the end of QT at Jackson Hole, to help signal to the market and help liquidity. The stock market going down 5-10% should have little impact on monetary policy- and it is not a fed mandate, but a failure of the market to allow credit worthy borrowers to obtain credit is a completely different story. Incidentally we do have a market problem in providing small business borrowers and retail clients access to credit at a reasonable price. The basis between these borrowers and US Treasury bonds is too wide. This will eventually bite and the FOMC should head this off- which is why my view is the FOMC should cut rates 50 at the next meeting.
I wrote my comment before reading yours but you’re completely right. The Fed might come to the rescue of credit markets as financial instability can occur if companies can’t refi, but they definitely should not be coming to the rescue of equity markets.
Calls for an emergency cut don’t just seem laughable now, they were laughable on Monday as well.
The S&P500 wiped out three months of gains after multiple years of almost one way traffic – cry me a river.
Credit was orderly and there were clear market structure reasons behind the move (stretched JPY carry trades, stretched equity allocations at vol targeting AMs etc).
We know the Fed will step in on signs of REAL stress, we don’t have free markets, but lets keep some semblance of them and not come to the rescue of every investor that truly believes “stonks only go up”, whether retail or institutional. Supposedly serious/intelligent voices who called for such a move should be ashamed of themselves.