What do you think of the “regular seasonal soft patches” so far? Stock markets have spent the past week trimming the range left by last Friday’s sell-off while grappling with the ghosts of past crises: regional bank balance sheet concerns, the possibility of another escalation in the China trade war, a temporary correction in cryptocurrencies, and reversals in some of the most speculative and fundamentally weak stocks. The S&P 500 rose 1.7% for the week, with most of that coming from Monday’s rebound, which put it in the equivalent of a five-week trading range surrounded by an all-time high above 6,750 and a twice-tested low at 6,550. Going into last week, nearly everyone in line with the consensus bulls pointed to the benefits of AI investing, the Federal Reserve poised to cut rates twice more this year in a still-strong economy, and the god-given right to a bull market that tracks year-end performance. Along with the difficult premises of these arguments comes the standard disclaimer that you should be prepared for some volatility in October along the way. Some of that is happening now, but the net effect so far is the mildest of rebounds, at worst 3% short of all-time highs. But last week saw a visible rise in anxiety, reflecting a lull in the previous low-volatility rally and possible pent-up selling from historically elevated equity allocations. The rise in the index pushed the total stock allocation of Bank of America’s wealthy clients to 64%, just shy of the highest level in 20 years set in late 2021. This suggests that there has been heavy inflows into stock funds from wealthy households in recent months, and there is little need to replenish stock balances. While long-short hedge funds failed to capture much of the initial surge from April’s correction lows, they were largely “re-risked” over the last week based on cycle-high gross and net leverage among BofA’s prime brokerage clients. Tactical quick-money players have undoubtedly retreated over the past week as they face the choice of locking in their annual fourth quarter or leaving it alone. Tony Pasquariello, head of hedge fund coverage at Goldman Sachs, said the group last week executed “the biggest sell-off (with a significant increase in macro shorting) in both U.S. and global stocks” since April, adding, “I think various market players are still holding long enough, but the market has actually removed some risk over the past two weeks, and we believe the technicals will improve as we move into October.” It’s impossible to prove, but it seems like the market has taken a bit of a hit as well, coinciding with anniversaries and milestones that made investors realize how generous the market has been. This bull market just celebrated its third anniversary, with the S&P 500 compounding at a 24% annual rate over that period and valuations rising to the high end of its post-pandemic range. It also surpassed the six-month milestone since April’s tariff-panic lows, pushing prices up an explosive 40% from low to high. And in recent weeks, the S&P 500 rose above 6,666 for the first time, marking a 10-bagger from the financial crisis low of 666 set in March 2009. The index has surpassed that level in each of the past six trading days, closing 2 points lower on Friday. First sign of volatility in a while All this nostalgia aside, the fall from record highs probably felt worse than it looked on the charts. That’s because it interrupted an unusually long and sleepy rise in prices. Prior to Oct. 10, 48 days had passed since the S&P 500 index had fallen 1% in a single day. The decline also ended the index’s longest streak above its 20-day moving average. And according to Warren Paiz, founder of 3Fourteen Research, the index has been 123 days since its last 3% pullback, one of the 12 longest gains on record, and the gain in that period was the highest of any such streak at the 123-day mark. Encouragingly, Pais examines the numbers that followed such streaks and concludes that such modest gains rarely occur at the end of a bull market. And market performance after the Fed’s failure was significantly better when the Fed’s next action was to cut rates rather than raise them. Even if the recent selloff wasn’t the start of a serious tailspin, there’s a good chance that the break in the harmoniously rotating, low-drama uptrend could unleash the volatility goblin for a while. The Cboe S&P 500 Volatility Index and its tracking futures rose much more than expected given the relatively modest index pullback, with the VIX rising from 16 on October 9 to a high of over 28 on Friday before falling below 21. .VIX YTD Mountain Cboe Volatility Index (Year-to-date) This promises to be the kind of thing that will be surging up the charts which means the anxiety attack is fading and we are trending upwards. A tactical buy signal may be flashing. Or perhaps the excitement around AI and recent strong momentum moving in and out of speculative theme subsectors means we could be entering an even more explosive phase of the bull market. Three weeks ago, when I was gushing about the signs of an acceleration toward a more euphoric environment, I said: “Another characteristic of a market growing toward a volatile bubble episode is that volatility is rising with stock prices, contrary to widespread adverse interactions. The exciting and volatile run of 1999 caused such a phenomenon, when the CBOE Volatility Index rarely fell below 20 as the S&P 500 rallied.” 20% And the Nasdaq Composite Index soared 85%. ”It is too early to say for certain that this is the current situation, but it cannot be ignored. Credit concerns The volatility may also indicate a resurgence of credit concerns related to losses from a series of “one-off” commercial bankruptcies, some of which are suspected of fraud, and smoldering concerns due to a somewhat looser non-bank lending environment and the uncertain structure of the burgeoning private credit sector. There were more false alarms than real alarms when it came to the decline on credit contagion concerns, but above all, the movements in alternative asset managers, regional banks, and investment bank Jefferies Financial undermined the sense of security many investors had in historically tight corporate bond spreads. Signals of a deterioration in the credit cycle are most important for the stock market. That’s because it would go against the consensus that the Fed would cut rates a little more for “warranted reasons” with the economy still strong. The same applies to the escalating rhetoric of trade hostilities between the United States and China. To remain aggressively bullish now, we need to choose a bright side interpretation of some apparent contradictions. One is the gulf between weakening individual commercial credit and still-sound indicators of corporate credit. Another is the disparity in that all job market indicators are near stalling rates, while GDP tracking models are showing above-trend growth. The third is gold’s tenacious strength. Traditionally a risk-off asset that feeds on the fear of disaster, gold has recently become a globally accepted momentum trade and a “universal diversifier” against rising stock prices, excessive government debt, an unreliable US dollar, and cryptocurrencies that move with technology frenzy. @GC.1 Year-to-date Mountain Gold, Year-to-date Going into Friday, traders were spooked by recent declines in stock prices, bond yields, the dollar, and oil (signals of disinflation and slowing growth), as well as continued gold buying even at large price increases. In this context, Friday’s $100 drop in metal prices from a record high of over $4,380 an ounce came as a mild relief to stock traders. Of course, it remains to be seen whether this will cause a more chaotic unwinding of gold, and how stock prices will correlate with such a reversal. Do we need proper fear? Some of the more heated, but not the same size, stocks like Meme have blown out without causing much disruption to the market’s core large-cap stocks. Quantum computing giants AeonQ and Righetti Computing have both fallen more than 20% in two days following incredible stock gains, and Robinhood shares have fallen 15% in six trading days. With any luck, more fundamental issues may be in the spotlight next week. According to FactSet, earnings reports are expected to start picking up in the coming weeks, with year-over-year growth of more than 8% (14.9% for the Seven Magnificents and 6.7% for the rest). With profits and profit forecasts still trending upward, and the US federal deficit still near 6% of GDP, it’s hard to see the economy and markets in such trouble. Last week’s actions didn’t really solve anything, but they didn’t break the bounds of purely routine integration. Those who reviewed the tape noted the relatively weak market reaction to Taiwan Semiconductor’s impressive performance and Oracle’s ecstatic growth prospects. On Friday, 52-week lows exceeded highs on both major exchanges. Friday’s gains in financial stocks were less impressive. This group has a lot to prove, as the sector is barely above its high from late 2024. And is it a bit too common for the S&P 500 to experience its first significant decline in six months and end up just one point above its 50-day moving average, as it did at last Tuesday’s low? The ideal scenario for the rest of this year would be for the recent turmoil to last a little longer before being seen as a suitable scare, skimming the speculative elements and resetting expectations in a way that rebuilds investors’ ability to be surprised on the upside.
