According to Bloomberg, Wall Street has recently witnessed a dramatic shift from fear to greed, with the market turbulence of recent weeks potentially serving as an extreme example of a long-standing trend in modern finance: increasingly frequent shocks. The volatility that erupted has since calmed, with the S&P 500 posting significant gains. These rapid reversals pose challenges for those attempting to rationalize market movements. The August downturn, followed by a swift recovery, highlights the growing fragility of markets over the past 15 years.
Past market disruptions have often involved crowded trades and liquidity issues, both of which were evident in 2024. Various assets, including Bitcoin, the Swiss franc, investment-grade credit, copper, and Japan’s Nikkei 225, were affected, underscoring the pervasive fragility and dysfunction in markets during times of stress due to extreme supply and demand imbalances. Systematic funds significantly reduced their stock exposure last week, and quantitative traders faced pressure.
This week saw a major rally, with stocks, bonds, and credit rising together. The S&P 500 achieved its best weekly gain of the year at 3.9%, ending a four-week losing streak. The largest Treasury exchange-traded fund rallied about 1%, while investment-grade and junk bonds also saw gains. Gold reached $2,500 for the first time. The VIX, a measure of market volatility, dropped below 15 after peaking above 65 during the turmoil.
Recent data has led traders to reassess their Federal Reserve expectations following positive inflation signals. The focus has shifted from the Fed, interest rates, and inflation to earnings and economic slowdown concerns. Despite bond market warnings of economic weakness, all 11 main equity sectors rallied this week. With the Fed poised to cut interest rates in a still-growing economy, investors are now concerned about missing out on a rally in riskier assets and have started unwinding their recent hedges.
As sentiment potentially shifts back toward euphoric levels, the likelihood of another disorderly market event increases. Some investment professionals, particularly those offering portfolio insurance known as tail-risk hedging, argue that markets are becoming increasingly fragile. Factors contributing to this fragility include investor herding, questionable liquidity, and the rise of volatility-sensitive investors who make decisions based on technical triggers rather than economic fundamentals.
