(Bloomberg) — The great market rally of 2024 appears dangerously close to unraveling as Wall Street’s once invincible bull brigade begins retracting its gains.
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With Treasury yields rising, the Federal Reserve on the rise, and conflict escalating in the Middle East, money has just been moved out of stocks and junk bonds at the fastest pace in more than a year. Dip buyers are muzzled. The S&P 500 fell every day this week, with the top seven tech giants closing nearly 8% lower as stock volatility increased.
The reversal is fueled by a revival of tensions that bulls may be less likely to shake off after posting trillions of dollars in trading gains since late October. The first of these is evidence that inflation has replaced recession as central bankers’ main enemy. With commodity prices soaring and economic data stubbornly rising, speakers led by Chairman Jerome Powell have dashed hopes for a long-awaited turnaround in monetary policy.
It provides a backdrop that justifies a defense, said 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 think we need to be more conservative in our allocation,” Rooney Vera said by phone. “I would rotate out of high-flying stocks right now and put that into really high-yielding short-term paper.”
This view suggests that often ignored imbalances in asset valuations are beginning to matter again. With Treasury bonds selling off, 10-year Treasury yields fell above 4.6%, about 40 basis points above the so-called earnings yield of the S&P 500. This gap, the rough basis for a valuation tool known as the Fed model , could be considered the least favorable for stocks since 2002, relatively speaking.
Starting six days lower last Friday, the S&P 500 posted its biggest losing streak since 2022, extending its April loss to more than 5%. Two-year Treasuries saw their yields briefly rise above 5% on Tuesday, part of a fixed-income rout that has wiped out gains in high-yield and investment-grade bonds for the month.
Traders this week noticed a deliberate attempt by central bankers to limit their bets on an upcoming easing. Powell said Tuesday that it will likely take “longer than expected” to gain the confidence needed to cut rates. A day later, Fed Governor Michelle Bowman warned that progress on inflation may have stalled. Asked whether it would be appropriate to keep rates stable throughout the year, Minneapolis Fed Chairman Neel Kashkari said Thursday: “potentially.”
The aggressive stance fueled the selling pressure that has been building among the ranks of investors. Redemptions from stock funds reached $21.1 billion in the two weeks through Wednesday, the highest since December 2022, according to Bank of America, citing data from EPFR Global. Investors pulled money out of junk bonds at the fastest pace in 14 months, data from LSEG Lipper shows. Hedge funds have ramped up short positions in U.S. exchange-traded funds at the fastest pace since 2022, Goldman Sachs Group Inc. prime brokerage data shows.
“There are weak hands that are selling, and they will continue to do so because they weren’t keen to buy in the first place,” said Peter Tchir, head of macro strategy at Academy Securities Inc. stocks with high valuations, now about a month later the trades aren’t working.
Market-implied expectations for monetary easing have collapsed over the past two weeks as traders price in fewer than two rate cuts this year. That’s down from six earlier in 2024.
Tensions in the Middle East have reinforced the more cautious attitude. Israel reportedly hit back against Iran on Friday morning and while the latest tensions have remained under control, concerns remain about a wider war in a region already roiled by the Israeli-Hamas conflict, pushing oil prices above $100 per barrel could rise.
Investors today are facing a stack of risks they’ve been able to live with before, thanks to resilient corporate earnings and brisk economic growth. The S&P 500 is up 16% since Hamas attacked Israel, 17% since 10-year Treasury yields peaked in 2023, and about 20% since the Fed started raising rates two years ago.
Yet the sheer size of market gains threatens to work against risky assets in the future.
Valuation concerns are mounting across the stock ecosystem, particularly the Nasdaq 100, whose seven largest members saw their worst weekly decline since November 2022. Cheaper-looking companies are once again outperforming their often AI-enabled growth counterparts. The Russell 1000 Value Index fell 0.7% this week, compared with a 5% decline in its growth counterpart.
“There has been a tremendous amount of faith-based investment in AI, driving up the valuations of many mega-cap tech companies,” said Max Gokhman, head of MosaiQ Investment Strategy at Franklin Templeton Investment Solutions. “A value consideration seems increasingly attractive and it is something we are actively discussing.”
–With help from Lu Wang.
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