Michael Reinking:
Good morning. I'm Michael Reinking, senior market strategist at the New York Stock Exchange, and you are listening to the Market Storylines podcast on the Inside the ICE House feed. Wondering what this is all about? Well, moving forward, every Friday, I'll bring you the latest market storylines of the week and a sneak peek at what's coming up next. Don't worry, the Inside the ICE House team will still drop their weekly episodes every Monday. So as we record on Thursday afternoon, let's dive into this week's market storylines.
There's no bigger storyline than the recent declines in global markets, which came to a head at the start of this week, with multiple market-wide circuit breakers triggering in Asia on Sunday night and the single worst single day decline in Japan since 1987. This weighed on global equity markets, but the losses were somewhat more contained with the S&P 500 opening down around 4% on Monday. The VIX briefly hit 65, the highest level since 2020. This is often referred to as Wall Street's fear gauge.
In actuality, it measures how much the market thinks the S&P will fluctuate by measuring implied volatility in S&P 500 options. At 65, that implies a nearly 20% up or down move in the next 30 days. That gauge has been cut in half throughout the week, but it's still around two and a half times higher than where we were for much of the year. There have been a culmination of events that led us to this moment, some of which the seeds were planted over a decade ago, and some a function of the persistently low volatility environment.
Since this is our first episode together, I'll try to spend a little more time talking about how we got here and trying to explain some of the dynamics at play. I will bury the lead and tell you from my perspective, a lot of what we're seeing is about the unwinding of crowded positioning and purging of leverage in the system, but there have been some fundamental factors that accelerated that unwind.
To put things in perspective, through the middle of July, the S&P 500 was up nearly 20%, adding to the 24% gains last year. And that rally had gotten increasingly concentrated with the AI optimism driving gains in the mega cap tech stocks. In fact, until the very end of July, there hadn't been a 2% decline on a single day since 2022, the longest streak since before the great financial crisis. Which leads into a discussion about quantitative investment strategies and how they have increasingly impacted the investment landscape.
These strategies are the alphabet soup of finance that come in lots of shapes and sizes. Here are a few that are relevant to today's conversation. CTAs or commodity trading advisors that use futures primarily for trend following. Volatility selling strategies have been very profitable and become quite popular, and there are vol target funds which adjust portfolio risk based on the level of volatility. The low volatility environment and trendy markets allowed to build up across these strategies.
One of the larger positions has been carry trades where investors have been structurally short the yen to fund other high-yielding assets. But what happens is when volatility begins to pick up, there are risk management guidelines put in place to begin reducing exposure. That unwind is very systematic and largely price insensitive and can feed upon itself. And in this case, many of these crowded trades began to unwind at the same time.
In equity markets, this first looked like a rotation which was triggered by the better than expected CPI report in the middle of July and markets began to aggressively price in rate cuts in the fall. There were violent moves out of the tech leadership into other areas of the market that have underperformed. At the most extreme was the Russell 2000, which was heavily shorted as these companies are more dependent on financing.
With the prospect of rate cuts, this index rallied sharply, outperforming the NYSE FANG+ Index, which tracks 10 of the largest tech companies, by around 25% in a matter of days. When this began, the VIX was around 13, but started to move into the high teens. At the same time, the yen began to strengthen and volatility picked up in FX markets and commodity markets, which as highlighted earlier, all leads to a deleveraging or de-grossing event, which is partially what we've been experiencing.
Now, last week was chock-full of catalysts, which seemed to accelerate some of this, including the Central Bank of Japan surprising markets with a rate hike, triggering an unwind of the carry trade. After the Federal Reserve left rates unchanged in the middle of the week, there were multiple pieces of disappointing economic data capped off by a weak jobs report on Friday, which amped up concern that the central bank was behind the curve and would need to cut rates more aggressively.
This also forced markets to rethink its soft landing stance and to reprice risks to reflect some probability of a hard landing. On Friday, the VIX had traded up to nearly 30, signaling some strains within the market, but I don't think anybody expected the moves that we saw in Asia over the weekend. After the carnage on Monday, markets have been trying to stabilize. As stated earlier, I believe much of this is related to a positioning unwind that has been ongoing for a couple of weeks.
But the exit is narrow when everyone rushes for the door, and this is happening at a difficult seasonal time period as liquidity is typically a bit lower in the summer. In these types of environments, there are aftershocks, which we've been seeing as the systematic flows have overwhelmed any rally attempts, especially late in the day. The VIX has remained elevated and it will take some time for charts to repair and for volatility to contract before these quantitative strategies begin deploying capital more aggressively again.
With the rally earlier in the year, markets had gotten stretched, leaving them susceptible to a pullback as they were priced for perfection. In terms of the economic backdrop, there have been signs that activity has been slowing for some time, but none of the data suggests the economy is falling off a cliff. Looking at credit markets, we have seen some widening of credit spreads, but they remain at low levels, not suggesting there is something larger brewing beneath the surface.
This week has been mostly about the trading without a lot in the way of macro catalysts, which is why I spent a lot of time with the deep dive. But next week, the macro calendar gets more interesting with U.S. inflation data, retail sales, and regional surveys, which will give us our first look at August data. We'll also get an update on the state of the consumer as we have earnings from major retailers, including Home Depot and Walmart.
Next week, I'll make sure to spend some more time talking about themes and takeaways from earnings season thus far. I want to thank you for spending some time with me today and let you know that our daily market commentary is available for public consumption on the NYSE.com homepage. Remember to tune in every Friday to the Market Storylines Podcast on the Inside the ICE House Podcast feed and rate review and subscribe wherever you get your podcasts. Thanks for listening. I'm Michael Reinking. I'll talk to you again next week.
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Information contained in this podcast was obtained in part from publicly available sources and not independently verified. Neither ICE nor is affiliates make any representations or warranties, express or implied, as to the accuracy or completeness of the information, and do not sponsor, approve, or endorse any of the content herein.
All of which is presented solely for informational and educational purposes. Nothing herein constitution offer to sell, a solicitation of an offer to buy any security, or a recommendation of any security or trading practice. Some portions of the proceeding conversation may have been edited for the purpose of length or clarity.