Global markets experienced a significant upheaval as traders reacted to recent economic data, unwinding bets that had dominated much of the year.
Japan’s Topix index suffered a dramatic fall of more than 12%, marking the most substantial sell-off since the “Black Monday” crash of 1987.
This selling wave extended into US and European markets, with Wall Street’s S&P 500 dropping around 4%.
Why the stock sell-off?
The primary catalyst for this market turmoil was recent economic data, which challenged the prevailing belief that global policymakers, particularly the US Federal Reserve, could cool inflation without severe collateral damage.
The most striking data came from the US jobs report released on Friday, which indicated a much sharper slowdown in hiring than anticipated.
This report heightened fears that the US economy is under significant strain due to high borrowing costs.
Corporate executives have noted that consumer spending, a critical driver of the US economy, is beginning to decline.
“Entering this year, investor expectations were for a ‘Goldilocks’ outcome,” said JPMorgan equities strategists.
However, this optimistic narrative is now being “severely tested.”
Goldman Sachs revised its forecast over the weekend, now estimating a one-in-four chance of the US entering a recession within the next year, up from a previous 15% likelihood.
Signs of economic distress are also evident in other regions, with eurozone business surveys highlighting the impact of geopolitical tensions, weaker global growth, and fragile consumer confidence.
Meanwhile, China’s dominant manufacturing sector showed signs of easing activity in the three months leading up to July.
Severe market ructions explained
Global equity markets had been on an upward trajectory, buoyed by hopes of a “Goldilocks” economic scenario and a surge in US tech stocks driven by enthusiasm for artificial intelligence technology.
The S&P 500, considered the world’s most critical equities barometer, had rallied nearly 20% from the start of the year, reaching a record high on July 16.
However, market pullbacks are typically swifter than the gains. Since its July peak, the S&P 500 has fallen more than 9%.
The rise in equities had also made stocks appear more expensive, with the S&P 500 trading at approximately 20.5 times expected earnings over the next 12 months, compared to an average of 16.5 since 2000, according to FactSet data.
The VIX index, often referred to as Wall Street’s “fear gauge,” spiked to 50 points from 16 points just a week ago, the highest level since the 2020 COVID-19 pandemic, indicating that more market volatility could be ahead.
The tech sector’s Magnificent 7 have a pivotal role
Investors have been particularly concerned about the heavy reliance on a small number of tech stocks, known as America’s “Magnificent Seven.”
Apple, Microsoft, Alphabet, Amazon, Tesla, Meta, and Nvidia accounted for 52% of the year-to-date returns on the S&P 500 through July, according to Howard Silverblatt, a senior analyst at S&P Dow Jones Indices.
These stocks are now under pressure, transforming their once-positive market influence into a significant factor in the sell-off. The tech-heavy Nasdaq Composite index has dropped around 14% from its July peak.
The tech sector’s troubles were exacerbated by news that Warren Buffett’s Berkshire Hathaway had halved its stake in Apple as part of a broader shift away from equities, leading the billionaire investor to offload $76 billion in stocks.
Other tech-related concerns have also surfaced, such as Intel’s announcement to cut 15,000 jobs in a sweeping turnaround plan, causing its stock to tumble about 30% last week.
Similarly, anxiety over the sustainability of an AI-driven boom in demand for specialized chips has weighed on sentiment, with chipmaker Nvidia falling 35% from its June highs.
Japan’s stock market hit hardest
Japan’s stock market has borne the brunt of the sell-off, erasing all its gains for the year following a plunge on Monday.
This decline was triggered by a rapid rise in the yen after the Bank of Japan raised its main interest rate to 0.25%, the highest level since the global financial crisis of late 2008.
This hawkish stance contrasted with expectations of a dovish shift in US monetary policy, leading to an unwinding of “carry trades” where investors borrow in low-rate countries to invest in higher-rate ones.
The yen’s more than 12% rally against the US dollar since the end of June to ¥142.5 represents a seismic move in currency markets.
A stronger yen poses a significant headwind for Japan’s exporter-heavy stock benchmarks.
Japan’s stock market, heavily exposed to the global economy, has become a primary target for risk reduction when global funds shift into panic mode.
Despite recent bullish rhetoric about Japan’s economic resurgence and the all-time highs reached by Tokyo stocks in July, this story had fragile support.
Domestic institutions and individuals lacked strong conviction in the market, leaving the heavy lifting of the rally to foreign investors, who can exit the market swiftly when sentiment turns.
What’s the fault of the US Federal Reserve?
The Federal Reserve’s decision last week to hold interest rates at a 23-year high above 5% was in line with investor expectations.
However, the weak July jobs report, which showed slower hiring and a rising unemployment rate, has spread panic that the Fed might have delayed lowering borrowing costs for too long, increasing the risk of a US recession.
Fed chief Jay Powell may face a challenging situation if market instability continues.
Markets are now pricing in 1.25 percentage points of Fed cuts, equivalent to five quarter-point reductions, by the end of the year.
Traders are also considering the possibility that the US central bank may be forced to react with an unscheduled emergency cut before its next meeting in September.
Global markets are undergoing significant turbulence due to rising concerns about the US economy’s trajectory. The sharp sell-off in Japan’s Topix index and the broader declines in US and European markets underscore the growing fears among investors.
Economic data pointing to a slowdown in hiring and consumer spending, coupled with high borrowing costs, has heightened recession risks.
The outsized influence of tech stocks and the contrasting monetary policies of major economies have further compounded the market volatility.
As traders brace for more potential turmoil, the focus remains on how global policymakers, particularly the US Federal Reserve, will navigate these challenging economic conditions.
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