The panic button is nowhere to be seen as the memory of the 7th S&P run fades

(Bloomberg) — Worried? Yes. But investors have shown little sign of panic amid a stock market slide that has wiped out $3 trillion from capital flows to options trading.

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A sign that nerves are in check: As the S&P 500 fell more than 3% on Friday, the Cboe Volatility Index, a gauge of options costs also known as the VIX, remained near 25, lower than the other six cases this year when stocks sold off like this.

Stock market investors, disappointed by Federal Reserve Chairman Jerome Powell’s hawkish remarks in Jackson Hole, quickly pulled money out of stocks. However, at $1.2 billion, the amount of withdrawals was about half the daily outflow seen around the June market low.

Light positioning among professional investors has helped keep sentiment in check. Funds are on the defensive, parking money in cash, while funds reduce exposure ahead of market catalysts like Powell’s speech and looming jobs and inflation data. The lack of a full capitulation is a sign that the carnage is far from over, especially when funds and rules-based pensions are expected to unload stocks in the coming days.

“The market is trading like an income hedge as opposed to an addition during the move lower,” said Danny Kirsch, head of options at Piper Sandler & Co. Or investors hope that this selloff will be limited.”

Stocks hit a two-week low, with the S&P 500 losing 0.7% on Monday. Traders continued to digest a series of hawkish remarks from the world’s top central bankers that inflation is here to stay and will require strong action to bring it under control. The VIX added 0.65 to 26.21.

“Friday’s VIX sub-30 close says this week could be somewhat worse,” said Nicholas Colas, co-founder of DataTrek Research. “Another day down +3 percent would not be a surprise, and we suggest looking for a VIX close in the 30s before building new long positions.”

Sentiment was cautious in Powell’s speech on Friday, after a two-month rally since mid-June forced short sellers to ease bets. During the week through Thursday, hedge funds tracked by Goldman Sachs Group Inc. have been busy boosting short positions, particularly through macro bets like ETFs or index futures. Their across-the-board macro sales were the biggest in eight weeks.

At Morgan Stanley, hedge fund clients kept their positions light. As of Thursday, leverage among long-dated mutual funds stood at 43 percent, down from 48 percent two weeks ago and down from 88 percent over the past five years.

The firm’s trading desk warned of further selling pressure from computer-based traders as well as funds needing to rebalance their asset allocation at the end of the month. Systematic macros, which were buyers of about $8 billion of stocks last week, will now turn to sellers this week, possibly offloading $10 billion to $15 billion of stocks as volatility rises, the team’s model shows. Meanwhile, pension and asset allocators are likely to sell $10 billion worth of shares.

Investors hoping for a friendly Fed just got a rude awakening that the central bank, laser-focused on saving hot inflation, is no longer the market’s big ally. Lowering prices “is likely to require a sustained period of below-trend growth” and rising unemployment, Powell said Friday at the Fed’s annual policy forum in Kansas City.

Despite the massive valuation correction, stocks are still far from obvious bargains. At the June low, the S&P 500 was trading at 18 times earnings, a multiple that beat the bottom valuations seen in all of the previous 11 down cycles since the 1950s. In other words, if stocks bounce from here, that bottom of the bear market would be the most expensive on record.

With higher interest rates putting pressure on stock valuations while an earnings downgrade cycle is underway, there could be more market turmoil, according to Jason Trennert and Ryan Grabinski, strategists at Strategas Securities.

“The biggest risk to the economy and markets may be the need for the Fed to tighten more than risk markets expect,” they wrote in a note. “Market bottoms are typically associated with lower earnings multiples, higher VIX and a burst in high-yield spreads. I haven’t seen it yet.”

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