Recession Jitters: Nasdaq Oversold Rebound on the Horizon?
Last week, U.S. stock markets experienced yet another wave of selling, driven by escalating concerns about a sharp slowdown in the American economy. This environment has led to increasing expectations for interest rate cuts from the Federal Reserve, placing continued pressure on the technology sector. The recent spike in market volatility was underscored by the Chicago Board Options Exchange's Volatility Index (VIX), which surged past the long-term average of 20, reaching a peak of 29.66 — the highest level since March 2023. Looking ahead, while there are relatively few risk events on the calendar for the coming week, investors are left pondering whether a short-term rebound might be on the horizon as they weigh the outlook for the U.S. economy and the possible direction of monetary policy.
In a significant shift last week, the Federal Reserve held a meeting where the policymakers acknowledged progress toward the central bank's 2% inflation target. Notably, the emphasis in monetary policy has shifted from inflation concerns to employment metrics, a pivot reflected in the removal of the phrase that primarily focuses on “heightened inflation risks.” Instead, the Fed recognized the dual risks facing policymakers today while indicating that rate cuts could be considered at the upcoming September meeting.
Advertisement
Recent labor market statistics offered a stark warning, as the U.S. Department of Labor reported an increase of only 114,000 non-farm jobs for the last month, significantly below market expectations. The unemployment rate surged to 4.3%, a figure that is nearing a three-year high. These troubling data points have fueled fears that the pace of economic slowdown may be more precipitous than anticipated. Bob Schwartz, a senior economist at Oxford Economics, commented that the unexpected rise in unemployment could trigger the "Sam Rule," which historically indicates recession; however, he pointed out that this rule's current signals lack reliability owing to the unemployment increase being concentrated within a narrow demographic associated with growing labor supply.
Market sentiment for potential rate cuts has surged dramatically, with medium to long-term U.S. Treasury yields plummeting. The closely watched two-year Treasury yield dropped by 51.7 basis points, settling at 3.871% — its lowest since May of the previous year. Meanwhile, the benchmark ten-year Treasury yield fell 40.4 basis points to 3.495%, marking an eight-month low. According to the CME Group’s FedWatch tool, there is now over a 70% probability that the Federal Reserve will initiate a 50 basis point rate cut at the September meeting.
As a result, Wall Street’s major institutions have revised their forecasts for interest rate trajectories accordingly. Morgan Stanley predicts that the Fed will implement three consecutive rate cuts starting in September, with core PCE inflation projected to decline to 2.1%. Similar assessments were noted by Bank of America, Goldman Sachs, and Citigroup, indicating a consensus among prominent financial entities regarding forthcoming monetary policy adjustments.
Schwartz elaborated on the Fed's internal conversation, suggesting that while there’s a growing inclination to prepare for rate cuts, there’s simultaneously a need for increased confidence in inflation trending toward its target. Consequently, no explicit timeline has been provided. This cautious approach is aimed at avoiding preemptive shifts in monetary policy that could lead to market overreactions. The pattern of rising unemployment might convey a sense of the Fed lagging behind economic indicators; however, many officials maintain an awareness of the instability inherent in monthly employment reports and thus remain hesitant to react excessively to any single data point. Schwartz firmly believes that the odds of a rate cut in September are highly likely, with the risk of three total cuts within the calendar year, although decisions regarding November cuts will hinge on comprehensive evaluations of additional economic data.
The recent decline in markets has been sharp. Last week, the U.S. stock market broadly retreated, with the Nasdaq index being the first of the major benchmarks to enter a correction phase, registering a decline exceeding 10% from its historical highs.
Investor confidence has been shaken not only by disappointing employment data and recession fears but also by disappointing quarterly results from leading firms such as Intel, Amazon, and Arm, alongside lackluster performances from industry giants like Microsoft and Nvidia. These factors have rendered the technology sector one of the worst-performing on record since the beginning of the second half of the year. The Philadelphia Semiconductor Index has faced a nearly 19% drop over the past month, reaching a four-month low.
Quincy Krosby, chief global strategist at LPL Financial, stated, "The primary concern lies with valuations. The market is set on understanding the monetization potential of artificial intelligence from major technology companies. The significant players, such as Amazon, are confronted with the question: 'You have invested billions into infrastructure; what can you show us in return?'"
Before this latest dip, investors had slowed their buying pace, with persistent selling in tech stocks creating downward pressure on purchases. Data from the London Stock Exchange Group indicated that net inflows to U.S. stock funds last week amounted to USD 2.14 billion, a stark reduction of nearly 60% compared to the previous week. However, smaller-cap funds continued to attract capital, receiving USD 2 billion in a net inflow for the third consecutive week.
Michael Hartnett, a strategist at Bank of America, opined that an expected rate cut from the Fed could paradoxically lead to a further decline in stocks, as this shift in policy is often coupled with indications of an "adverse hard landing" for the economy rather than a gentle slowdown. Historical data since 1970 show that shifts toward easing policies in response to economic downturns have generally led to poor performance for equity markets while benefiting bond markets. Hartnett underscored that a crucial distinction for 2024 lies in the fact that risk assets have already dramatically factored in the Fed's anticipated cuts.
In a market outlook report, Charles Schwab suggested that the recent selling pressure stems primarily from weak economic data and growth-related apprehensions. The market appears to have shifted focus from initial concerns about inflation and potential Fed rate cuts—where bad news was often interpreted as good news—to a more somber perspective that frames unfavorable information solely as detrimental. This adjustment may lead investors to scrutinize forthcoming economic indicators with greater rigidity, meaning negative surprises could translate into tangible selling pressure on equities.
The pressing question moving forward is whether the Federal Reserve can adequately relax its policy constraints, both in breadth and timing, to facilitate a soft landing. The immediate market environment does not necessarily warrant pessimism, considering the VIX recently spiked to a year-high. Historically, this peak might signify that the market has overreacted, potentially identifying a near-term bottom for stocks. Overall, the economic calendar for the coming week appears light, which could pave the way for a corrective rally; however, confirming this as the definitive low for the current adjustment proves challenging.