The remarkable market rally of 2024 is showing signs of unraveling as Wall Street’s once-unstoppable bulls begin to withdraw their gains. With Treasury yields surging, Federal Reserve hawks gaining ground, and Middle East tensions escalating, investors have pulled out of equities and junk bonds at an unprecedented rate. The S&P 500 suffered a losing streak this week, with the top seven tech giants plummeting nearly 8%, and equity volatility soaring.
Chief among these concerns is evidence that inflation has supplanted recession as the primary nemesis of central bankers.
Fueling this reversal is an uptick in concerns that bulls can no longer ignore after raking in trillions of dollars in trading profits since late October. Chief among these concerns is evidence that inflation has supplanted recession as the primary nemesis of central bankers. With commodities surging and economic data remaining robust, Federal Reserve Chair Jerome Powell and other speakers have dampened hopes for a long-awaited pivot in monetary policy.
This shift in sentiment has led to a defensive market environment, according to Kathryn Rooney Vera, chief market strategist at StoneX Group. “In a world of high geopolitical risk, upside risk to commodity prices, and upside risk to inflation, I believe we need to be more conservative in our allocation,” Rooney Vera said. “I would rotate from high-flying equities and invest in high-yielding short-term paper.”
This view suggests that long-ignored valuation imbalances across assets are finally gaining attention. With government bonds selling off, the 10-year Treasury rate has pushed above 4.6%, about 40 basis points above the earnings yield of the S&P 500. This gap, a key metric in the Fed model, is the least favorable for equities since 2002.
The S&P 500 has extended its April loss to over 5%, with two-year Treasuries briefly pushing above 5% on Tuesday. This fixed-income rout has erased gains in high-yield and investment-grade bonds for the month. Traders sense a deliberate effort by central bankers to restrain bets on imminent easing. Powell stated that it will likely take “longer than expected” to gain confidence in lowering rates, while Fed Governor Michelle Bowman warned that progress on inflation may have stalled.
Hawkish posturing has fanned selling pressure across investor ranks. Redemptions from stock funds reached $21.1 billion in two weeks, the most since December 2022, according to Bank of America. Investors pulled cash out of junk bonds at the fastest pace in 14 months, and hedge funds ramped up short positions in US exchange-traded funds at the fastest pace since 2022.
“There are weak hands selling, and they will continue to sell, since they weren’t enthusiastic about buying in the first place,” said Peter Tchir, head of macro strategy at Academy Securities Inc.
“There are weak hands selling, and they will continue to sell, since they weren’t enthusiastic about buying in the first place,” said Peter Tchir, head of macro strategy at Academy Securities Inc. “People got sucked into chasing the rally, buying stocks at high valuations, and now the trades aren’t working.”
Market-implied expectations for monetary easing have collapsed in the past two weeks, with traders pricing in less than two rate cuts this year. Tensions in the Middle East have reinforced the cautious stance, with worries about a wider war in the region potentially sending oil prices above $100 a barrel.
Investors face a multitude of risks that they have previously shown themselves able to live with, thanks to resilient corporate earnings and economic growth. However, the sheer scale of market gains now threatens to work against risk assets going forward. Valuation worries are building within the equity ecosystem, particularly in the Nasdaq 100, whose seven biggest members saw the worst weekly drop since November 2022. Cheaper-looking companies have begun to outperform their growth counterparts, and a value overweight is becoming increasingly attractive.
“There has been tremendous faith-based investing in AI that pushed up valuations of many megacap tech firms,” said Max Gokhman, head of MosaiQ Investment Strategy at Franklin Templeton Investment Solutions. “A value overweight looks increasingly more attractive, and it’s something we are actively discussing.”
