Many traders pointed to the dwindling probability that the Fed will reduce interest rates again in December as the most likely trigger for the selloff
by Joel Leon
Federal Reserve policymakers are flying blind after the US government shutdown starved them of crucial data, and the uncertainty is testing the nerves of investors.
A sudden bout of risk aversion shook markets on Thursday, leading to a sharp plunge in some of this year’s highest flying stocks and worsening a recent slump in cryptocurrencies. The S&P 500 lost 1.7%, while the technology-heavy Nasdaq 100 tumbled 2%.
The weakness extended into Friday, with Europe’s Stoxx 600 index sliding as much as 1%, dragged down by technology shares, while US futures were falling. Asian stocks dropped the most since April, weighed down by tech names. Bitcoin fell further below $100,000, sinking as much as 2.8% on Friday and taking its retreat from an October record to more than 20%.
Many traders pointed to the dwindling probability that the Fed will reduce interest rates again in December as the most likely trigger for the selloff. Swaps traders are pricing in about a 50% chance of a cut, down from 72% a week ago, with Fed officials failing to signal conviction for such a move in recent remarks.
Uncertainty about what the Fed will do next underpinned much of the anxiety seen in the market on Thursday. Policymakers are grappling with elevated inflation as well as a weakening job market, all while lacking insights on both after the longest government shutdown on record forced cancellation or delays of crucial economic reports.
Gauges of what are known as high-momentum equities, as well as those favored by retail investors, bore the brunt of Thursday’s selling. Bank of America Corp.’s basket of high-momentum stocks dropped 4.7%, its worst day since April during the height of President Donald Trump’s tariff threats. The basket had rebounded as much as 63% from its April lows through Monday.
The momentum strategy focuses on buying recent winners and shorting stocks that have lagged behind. Some of the winners have been artificial intelligence-linked stocks, which have seen their valuations swell amid the market euphoria around the technology.
“The promise of lower interest rates had been a reason why many investors were willing to disregard the high valuation readings on the momentum stocks,” said Matt Maley, chief market strategist at Miller Tabak + Co. “Now that the promise is becoming less compelling, investors are peeling back some of their exposure to these expensive names.”
High-momentum equities tend to be growth stocks that benefit from lower interest rates because that reduces the discount rate in valuation models, allowing their price-to-earnings multiples to expand, according to Michael O’Rourke, chief market strategist at JonesTrading.
“If interest rates are not going to come down as quickly as investors believed, then the expectations reset prompts selling to contract the P/E multiple to adjust for the new outlook,” he said.
Beneficiaries from the AI rally had already started to fade in recent weeks, as concerns over stretched valuations and massive capital expenditures led investors to take profits. AI-linked names in Bank of America’s momentum basket plunged on Thursday, with Sandisk Corp. sinking 14% and Astera Labs Inc. dropping 8.4%. Among large-cap stocks related to AI, Nvidia Corp. lost 3.6%, Broadcom Inc. fell 4.3% and Palantir Technologies Inc. slid 6.5%.
Euphoria Index
The risk aversion appeared to be especially acute in stocks favored by amateur traders. Barclays analysts recently flagged a “significant decline” in retail trading activity based on their equity euphoria index.
The Citi US Retail Favorites basket sank 6% for its biggest plunge since April 4. The gauge, which includes companies like Tesla Inc., SoFi Technologies Inc. and Riot Platforms Inc., had almost doubled in the 12 months through Oct. 15, and has lost 15% since. A meme-stock ETF anchored by Opendoor Technologies Inc. plunged more than 11%, its worst day since launching last month. The VanEck Social Sentiment ETF and Cathie Wood’s ARK Innovation ETF each slid by more than 5%. Leveraged products tied to Bitcoin miners and quantum-computing firms saw even steeper declines — with some tumbling more than 20%.
Even the market’s least-loved stocks took a hit. A Goldman Sachs Group Inc. basket of the most-shorted companies with a market value greater than $1 billion slid 5.5% — also posting its worst daily performance since April.
The Washington shutdown came as Fed officials became increasingly divided on what to do with rates. Last month, after policymakers voted for a second-straight quarter-point reduction, Fed Chair Jerome Powell said another cut was far from a “foregone conclusion.”
‘Somewhat Restrictive’
On Thursday, St. Louis Fed President Alberto Musalem weighed in by saying officials should move cautiously with further rate reductions since inflation was running above the central bank’s 2% target. Minneapolis Fed President Neel Kashkari said in an interview with Bloomberg News that he didn’t support the last cut, and he’s still undecided on the best course of action for its December policy meeting. The Cleveland Fed’s Beth Hammack noted policy should remain “somewhat restrictive.”
“I can make a case depending on how the data goes to cut, I can make a case to hold, and we’ll have to see,” Kashkari said.
The uncertainty around the Fed’s rate path stretches to traders, as they wait for a backlog of official economic data to be released.
“The accumulation of headline-driven worries has created considerable churn in equity prices,” said Paul Christopher, head of global investment strategy at Wells Fargo Investment Institute. Investors should focus on the prospects for lower rates next year, he added. “Even a surge of delayed economic data is unlikely to change the trend in softer job creation, which state-level and private-sector data confirmed during the shutdown.”
Copyright Bloomberg News
