Stock market panics and plunges: US faces recession concerns, Buffett "half-steps out"

Author: Ji Zhenyu, Tencent News "Qianwang"

Global stock markets have entered a panic plunge mode.

In early August, the Bank of Japan and the Federal Reserve successively announced monetary policy decisions. The Bank of Japan announced a 25 basis point interest rate hike, while the Federal Reserve announced that the benchmark interest rate would remain unchanged, but it clearly released a signal that there is a high probability of a rate cut in September.

The market was moved by the news, and the yen-dollar exchange rate soared sharply, and the "carry trade" of borrowing cheap yen to enter the high-yield market came to an end. The Fed's clear signal of a rate cut only lasted for one day. In the trading day in early August, Japanese, European and US stocks experienced a comprehensive decline.

The greater concern comes from the negative signals of the US economic fundamentals. The ISM manufacturing index, which reflects factory activity, was lower than expected, the number of first-time unemployment claims hit a new high since August 2023, and the US non-farm payrolls data in July showed that the unemployment rate rose further. For a time, panic about the US economy's impending recession swept the market.

Criticisms of the Fed also followed one after another. Many economists pointed out that the Fed's path to make corresponding monetary policy adjustments based on economic data was too conservative and lagging. From the current situation, "standing still" in July was a wrong decision. In the future, the Fed can only make up for it by increasing the rate cut.

With the changes in the new round of economic data and the macro environment, investors' expectations have also begun to change. Expectations that the Fed will cut interest rates sharply before the end of the year have begun to dominate the market.

In addition to macro factors, concerns about whether generative AI can deliver on large-scale investment have also begun to put pressure on the market. In early August, trillion-level technology giants such as Microsoft, Google, Apple, and Meta released their financial reports. In this round of generative AI, although the giants are still making huge investments, the corresponding new revenue and profits have not increased proportionally, and Wall Street has begun to rethink the corresponding valuations.

In fact, since the beginning of this year, the overall rise of the US stock market has been mainly driven by the strong rise of giant companies that benefited from the concept of generative AI. The trend of funds concentrating on the head companies has intensified. Apart from these factors, the stock price performance of most listed companies in the US stock market is not very ideal. After this round of general correction of technology giants, the US stock market may enter a new round of adjustment period.

Another signal may support the above view. The latest second-quarter financial report released by Berkshire Hathaway, owned by "stock god" Buffett, shows that Buffett significantly reduced his holdings of Apple, the largest holding, by nearly 50% in the quarter, while cash reserves reached a record high of US$276.9 billion, a significant increase of 46.5% from the first quarter. The "stock god" who has been standing firm in the US stock market for more than half a century may have noticed the abnormality of the market in advance.

At present, "recession trading" occupies the mainstream in the market, and bearish sentiment is spreading, but on the other hand, the Fed's interest rate cut in September and the subsequent large-scale interest rate cut have also become high-probability events, which may provide conditions for the subsequent market to rise.

A person from a US private equity institution who worked for Citadel, Point72 and other institutions told Tencent News "Qianwang" that usually in extreme market conditions, investors are prone to such a dilemma. On the one hand, the previous positions suffered heavy losses and were easily affected by the extremely pessimistic market sentiment. On the other hand, some investors are considering "bottom-fishing", but from the current market conditions, it may take a period of correction, and blindly entering the market may be irrational. He suggested that ordinary investors make corresponding decisions after this round of volatility slows down and the market trend becomes clearer.

The global panic plunge has begun, and no major market has been spared

On August 1, the Dow Jones Index fell more than 700 points during the day, the S&P 500 Index fell 1.37% throughout the day, the Nasdaq Composite Index fell 2.3%, and the Russell 2000 Index, which covers more small and medium-sized enterprises, fell more than 3%.

On August 2, with the release of the latest non-farm payrolls report in the United States, the market not only showed no signs of stopping the decline, but the extent of the decline continued to increase. US stocks continued to fall across the board, with the S&P 500 index continuing to plummet by 1.84%, the Nasdaq Composite Index falling by more than 2.4%, and the Russell 2000 Index continuing to fall by more than 3%.

Investors' pessimism enveloped the global market, and almost all major markets were spared. Japan's Nikkei index continued to fall on August 1 and 2, setting the largest single-day drop in more than four years, and European stock markets also fell across the board.

On August 5, the Japanese stock market continued to fall at the opening, with the Nikkei 225 index falling by more than 4%, and the Topix index falling by 3%. Since January 11, the Nikkei 225 index fell below 35,000 points for the first time.

This round of decline in U.S. stocks was led by heavyweight stocks, including Apple, Microsoft, Amazon, Google, Nvidia and other technology giants with a market value of more than one trillion dollars, with declines ranging from 3-5%, and there are obvious signs of large-scale capital flight. The volatility index, which measures the degree of market panic, jumped 23%, the highest level since October 2023.

Market sentiment took a sharp turn for the worse, and multiple factors weighed on US stocks

On July 31, US time, the Federal Reserve's July interest rate meeting resolution was finalized. Although it did not announce a reduction in the benchmark interest rate, at this meeting, the Federal Reserve almost sent a clear signal to the market that it would start the first interest rate cut in September.

Investors' optimism on that day was obvious. The Nasdaq Composite Index, which is dominated by technology growth stocks that are most sensitive to interest rate levels, rose sharply by 2.64% on that day, and other sectors also saw a general rise to varying degrees.

However, such market performance was later verified to be short-lived. The day after the Fed's interest rate meeting, U.S. stocks began to plummet. The most direct cause was that the ISM manufacturing data for July released on August 1 was only 46.8%, lower than the market's previous expectations. The index reflects the factory activity in the United States and is generally considered to be a signal of economic recession.

Subsequently, the non-farm payrolls data released on Friday continued to increase investors' concerns. The July data showed that the U.S. unemployment rate rose to 4.3%, the highest level since 2021. Combined with the number of first-time unemployment claims in the week announced the day before, which hit the highest level since August 2023, it showed that the U.S. job market began to show obvious signs of slowing down.

The optimism about the Fed's interest rate cut lasted only one day, and market sentiment took a sharp turn for the worse. The original "optimism caused by the interest rate cut" instantly turned into "panic selling related to recession."

Some analysts began to criticize the Fed's monetary policy shift for being too slow and missing the best time to avoid a hard landing of the economy.

Some economists believe that the Fed itself has fallen into a very passive situation. On the one hand, the Fed has repeatedly publicly emphasized that it must rely on economic data to make corresponding decisions. On the other hand, due to the significant lag of economic data, if the Fed completely follows economic data to make corresponding monetary policy adjustments, it will inevitably be half a beat slower. Now the facts are developing towards an increasingly unfavorable situation for the Fed.

After the economic data showed obvious weakness and the Fed made it clear that there is a high probability of starting a rate cut cycle in September, the market has formed a new round of expectations for the Fed's rate cut. Investors expect that the probability of the Fed directly cutting interest rates by 50 basis points instead of 25 basis points in September has increased significantly.

Under such expectations, the Fed's policy making has fallen into a dilemma. On the one hand, if the Fed directly cuts interest rates by 50 basis points in September, it will undoubtedly announce to the outside world that the Fed had misjudged the situation before, and can only make up for the negative impact of its previous slow action through a one-time and larger rate cut. On the other hand, if the Fed still cuts interest rates at the previously planned pace of 25 basis points, it will not be able to curb the trend of rapid economic decline.

In addition, another major factor for the sharp correction of US stocks comes from external influences. The day before the Federal Reserve announced its monetary policy decision, the Bank of Japan announced a 25 basis point interest rate hike, and the yen-dollar exchange rate rose accordingly. The carry trade that had previously borrowed cheap yen to invest in the US stock market died down, which also had a negative impact on the US stock market in the short term.

In addition, the US stock market is in the earnings season. Some technology giants that have already announced earnings, such as Microsoft and Google, have maintained a solid performance fundamentals, but the new businesses related to generative AI that investors had high hopes for have not seen a significant increase in revenue and profits, but capital investment is still growing significantly. This reflects that the leading companies are still in the "arms race" stage, and the real added value generated by generative AI has not yet been fully reflected in the financial performance, which has also caused investors to begin to reposition the valuation of related listed companies.

The interest rate cut is clear, but the extent still needs to be discussed

After last week's sharp sell-off, investors are currently focusing on two aspects: one is whether the Fed is slow in adjusting monetary policy and how to form expectations for the Fed's next move; the other is whether the generative AI concept can continue to maintain the high valuations of some companies.

For the first question, many economists who closely follow the trend of the long-term have expressed their opinions. Julia Coronado, founder of the research institution MacroPolicy Perspectives, said that the Fed is definitely slow and they need to catch up.

Mark Zandi, chief economist of the rating agency Moody's, was more blunt, saying that the Fed made a mistake and they should have made the decision to cut interest rates a few months ago.

"It feels that making another 25 basis point interest rate cut in September is far from enough. A 50 basis point interest rate cut and more aggressive monetary policy measures are what the Fed needs to do," said Zandi.

Michael Feroli, chief U.S. economist at JPMorgan Chase, also believes that the Fed should make a decision to cut interest rates at the Federal Reserve Monetary Policy Committee's interest rate meeting at the end of July. Under the current circumstances, they have to cut interest rates as soon as possible.

He expects the Fed to make two consecutive 50 basis point interest rate cuts at its monetary policy meetings in September and November.

The Fed monitoring tool updated in real time by the Chicago Mercantile Exchange shows that the market currently expects the Fed to announce a 25 basis point interest rate cut at the September interest rate meeting with a probability of 78% and a 50 basis point interest rate cut with a probability of 22%. By the end of this year, the last Federal Reserve interest rate meeting, the market expects that the probability of a cumulative interest rate cut of 125 basis points will be 2.6%.

But some economists have expressed relatively cautious views. Blerina Uruci, chief U.S. economist at T. Rowe Price, believes that a one-time 50 basis point rate cut currently looks a bit radical, which will clearly declare to the outside world that the Fed was indeed slow to act before, which may cause greater panic in the market.

She believes that the extent of the rate cut will also depend on the data of the August non-farm payroll report. If the data shows that the July data was simply over-interpreted due to weather factors, then Fed officials will think that a 25 basis point cut in the benchmark interest rate is more appropriate.