In a previous life, when I routinely shut down New York City bars, the end of Daylight Saving Time was an annual bonus, as 2am on a Saturday night instantly became 1am, leaving three more hours until closing time.
The financial markets now are undergoing several forms of late-cycle unease, and Wall Street is now looking for earnings season and the passage of the midterm elections to turn back the clock before last call.
To be clear, this remains a bull market, the S&P 500's uptrend unbroken, with constant rotations between AI tech and remainder of the market fitfully supporting the tape, with pullbacks limited to 3% for half a year.
Still, the index is now chopping around a flattish 50-day moving average at levels first reached 11 weeks ago, the AI-hardware cohort has badly broken stride, bank stocks are trading poorly off their results, and credit markets are getting colicky.
Late last week, the urgent selling in semiconductors and data-center equities and debt resembled the sort of forced-unwind rhythms from July, when a big upstart tech hedge fund was in the process of being all but liquidated.
A tentative bounce in semiconductor stocks Monday was minimally reassuring, in that it meant we didn't get the further disorderly purge many had braced for over the weekend (when S&P 500 "perpetual" futures on Hyperliquid had a sudden head-fake drop late Saturday).
Jason Hunter, technical strategist at JP Morgan, sets out the crucial question for a market sending mixed signals:
"With the bearish seasonal window now closing, we are left wondering if the market is in the terminal phase of a sequence of rolling corrections ahead of a typical late-year rally. Or are the plentiful amounts of bearish internal, momentum, and intra-market divergences that have formed as the S&P 500 index has decelerated below longer-term channel resistance setting the market up for a larger and more correlated setback?"
He leans toward a more cautious interpretation, keeping the S&P 500 on a short leash that extends about 2.5% lower to 7500, a break of which would lose the tape the benefit of the doubt.
Based on precedent and circumstance, the market "should" be setting up for a comeback that could reset the clock in bulls' favor. The fourth quarter after a midterm election year, historically, is overwhelmingly positive. Earnings growth projected to exceed a 20% year-over-year growth rate again this quarter can hardly be viewed as anything but a positive at least to bolster the fundamental case.
Still, against most probabilities, 2018 happened. By which I mean a 19% S&P 500 peak-to-trough decline in the fourth quarter of a midterm-election year, one that saw total S&P 500 earnings grow by more than 20%.
The 2018 tailspin had followed a massive momentum crescendo and reversal several months earlier, which gave way to an erratic tape that couldn't absorb what seemed at the time relatively unthreatening Federal Reserve tightening actions.
Financial conditions have now been tightening by means of higher Treasury yields, somewhat wider corporate-credit spreads, an uptick in volatility and a stronger U.S. dollar.
It's become common to hear investors insist that "the market is doing the Fed's tightening for it," suggesting Chairman Kevin Warsh himself should show restraint in further hiking rates despite the recent upturn in inflation. Sure, but the reason the markets are tightening is, in part, because Warsh himself expressed resolve in fighting inflation and investors therefore believe he'll take short-term rates up a bit more.
How Warsh treats these market shifts after next week's Fed meeting is another node of disagreement on the Street.
Bank of America economist Aditya Bhave says the markets are testing the Fed's pain threshold with the Nasdaq retreating 5% and credit spreads flaring a bit. The market has taken recent Fedspeak to suggest very low chances of an October rate hike, even though Warsh himself has decried forward guidance and said the Fed shouldn't suppress normal market volatility. Bhave is maintaining his non-consensus prediction for an October hike, conceding it's a close call.
Morgan Stanley equity strategist Mike Wilson takes the other side on the Fed's response to the recent tensing up of markets: "We think some acknowledgement of this tightening by Warsh would be well received by rate-sensitive areas that have already derated notably. Conversely, an indifference to this tightening may invoke memories of Powell's 2018 'auto-pilot' remarks in reference to that tightening episode."
The "de-rating" and "de-risking" process has surely been notable in recent weeks, with small and cyclical stocks under significant valuation pressure and hedge funds aggressively repositioning out of tech.
Is it enough to enliven buyers into or after the election?
Ned Davis Research thematic strategist Pat Tschosik notes his firm's proprietary market-breadth reading Big Mo Tape tentatively turning higher from oversold readings. "If Big Tech disappoints on Q3 earnings, we may get a full market washout and Big Mo could head even lower like it did in October 2023. Perhaps this is what is needed to set up for a post-midterm-election rally into yearend."
Market Temperature Gauge
John Kolovos of Macro Risk Advisors sees a similar level to JPMorgan's as the market's breaking point, while evaluating his sentiment indicator.
Kolovos on the latest reading: "A noticeable sentiment reset is underway on the heels of the AI trade unwind and tightening financial conditions. The good news is that bullish sentiment is finally starting to wash out, which should set the stage for a year-end rally. However, a break below the mid-September lows on the S&P 500 near 7,500 would warn that something more than a routine pullback is unfolding."
Around the Street
-There's something of a paradox at work – or a collective investor blind spot - when the bond market is finally offering relatively safe income after many years of meager yields and yet people continue to rush for the engineered income delivered by options-selling ETFs. This CNBC.com piece offers a thorough, smart rundown of these strategies, complete with warnings of tax pitfalls. This Bloomberg report details a more aggressive approach through funds many investors don't quite understand, while introducing me to the community of self-styled "dividend nomads."
-Anthropic's proposal to place 5% of its equity into a "public benefit fund" to help groups potentially disadvantaged by AI's propagation and Elon Musk's stated offer to give one of his SpaceX shares to every American child via Trump Accounts suggest that anxiety over AI economic disruption is going from simmer to boil.
We can cynically observe that such efforts also hype these companies' world-changing potency, a form of marketing through scare-mongering sheathed in generosity. But the concern over AI's impact on current worker groups is well-placed, even if ultimately society adapts around step-function technological change. The best hedge against AI-powered capital overtaking labor is arguably to own more capital, whether through the S&P 500 or other vehicles.
Or one could raise the value of one's human capital, through training or becoming excellent at something. This has always been Warren Buffett's answer for how one should become inflation-resistant, as he detailed at Berkshire Hathaway's annual meeting a few years ago, at the height of the pandemic inflation surge.
Market on Close
Bull markets can keep rolling for a long while after they've become fully embraced and stocks are no longer cheap. But I find myself cataloguing various ways that the cushions against adverse surprises are getting worn pretty flat.
Here's the running tally of investors' collective cash holdings as a percentage of total margin debt. It's running well below the levels of the year 2000 at this point.
Industry participants are quick to point out some extenuating factors: A massive jump in certain long-short tax-avoidance strategies that pushed up margin borrowing without representing true upside leverage. And investors these days often have their cash swept into bank deposits that might not be captured in this measure.
Still, whatever's driving it suggests high market exposures and a bit less cash buying power.
Here's a cut-to-the-chase relationship for comparing equities and bonds. Total shareholder yield – through dividends and share buybacks combined – now lags the yield on the 10-year Treasury note.
Not a bright flashing alarm, but a reason to assume that the hurdle rate for taking equity risk is a bit higher than it's been for most of the past 20 years.
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