The Haptic Market Lens: Unpacking the Perfect Storm of Early August's Equity Implosion - A Quant's Quest for Clarity
- the haptic investor
- Oct 11, 2024
- 7 min read
Crash? Correction? Cue?
No matter how you categorize the very event, the stock market crash on Friday, August 2nd, and Monday, August 5th, 2024, sent shockwaves through global financial markets, causing steep declines in major indices, including Japan's Nikkei and the US stock market. Since then, market developments and fundamental economic indicators have painted an increasingly complex picture, further unsettling investors due to high volatility and uncertainty. Adding to said uncertainty, legendary investor Warren Buffett made headlines by selling half of his Apple stock and significantly increasing his cash reserves. This article examines the prerequisite, latest developments and their implications from a fundamental and quantitative perspective.
Pre-Crash Environment:
The signs of a stretched market have been on display since mid-July. The yen carry trade had been in place for so many years that it became a dominant part of the market. As the yen strengthened and capital was reallocated, something had to break. Based on experience, a lot of yen debt has been flowing into bonds (sometimes in HY USD EM debt) that can be challenging to sell before maturity. The correlations between the Nikkei and the Philadelphia Semiconductor Index suggest that accrued interest income has been flowing into US tech and semiconductor stocks. Repatriating of money made investors sell what they can, not what they wanted (i.e. stocks instead of illiquid bonds).
Global financial news sentiment has been extremely positive for a very long period of time but started to roll-over at the end of June, coinciding with the peak in NVIDIA stock.
Source: macro.dcorr.de, own calculations
Approximated systematic model exposures, which at times are the biggest active flows, have been forceful over the last couple of months. After a big push at the end of 2022 to new all-time highs, starting in July, the reverse situation occurred. There was basically no dry powder left to push markets further from any systematic models. On the contrary, any pickup in volatility from bonds or equities would trigger strong selling pressure.
Source: macro.dcorr.de, own calculations
Sentiment and systematic investors positioning left the markets in a very vulnerable place. As big moves in futures started to happen, a cascade of derisking and reevaluation began.
Post-Crash Market Developments
Since the initial crash, the markets have continued to experience volatility, driven by a mix of economic data, corporate actions, and shifting investor sentiment:
Nikkei's Continued Struggles: The Nikkei 225 has struggled to recover from its early August plunge, with continued downward pressure stemming from a stronger yen and weak domestic economic indicators. However, over the last 5 days the yen has become stronger again. Despite efforts by the Bank of Japan to stabilize the currency, we all remember the 2008 financial crisis and the interplay of weakening markets, poor sentiment and falling exchange rates using the example of the US dollar.
US Market Volatility: In the US, the stock market has seen wild swings, with the Dow Jones, S&P 500, and Nasdaq all experiencing sharp daily fluctuations. The uncertainty around Federal Reserve policy has been a key driver. After initially holding rates steady, the Fed hinted at a potential rate cut in its September meeting, a move that provided temporary relief to markets. On the other hand, voice suggest, that a rate cut would be proof that the Policy Makers have made massive mistakes and that American Economy is struggling, due to the fact that American companies are unable to stabilize the market from within, as opinion and uncertainty are currently exerting enormous pressure. Even top quarterly figures from important companies are unlikely to completely dispel investors' concerns. What remains is uncertainty and skepticism. However, conflicting economic data, including weaker-than-expected consumer spending and a slowdown in industrial production, have kept investors on edge.
Bond Market Signals: The bond market has also shown signs of stress, with the yield curve inverting even further, a classic recession signal. The 10-year Treasury yield fell below 4% for the first time in nearly two years, while the 2-year yield remained elevated, indicating growing investor concern about the near-term economic outlook.
Global Economic Slowdown: Globally, economic indicators have continued to deteriorate. China's economy, in particular, has shown signs of significant strain, with GDP growth slowing to its weakest pace in decades. The Eurozone is also teetering on the edge of recession, with Germany, its largest economy, reporting a sharp contraction in industrial output and declining business confidence.
Warren Buffett's Strategic Shift
One of the most significant developments since the crash has been Warren Buffett's decision to sell half of his Apple stock, a move that has sent ripples through the investment community and putting pressure on other US Tech Firms. Buffett's Berkshire Hathaway had long been one of Apple's largest shareholders, and his decision to reduce his stake has raised questions about the tech giant's future prospects and the broader market environment.
Buffett's Sell-Off: On August 7th, 2024, regulatory filings revealed that Buffett had sold 50% of Berkshire Hathaway's Apple holdings, a move that amounted to nearly $150 billion in stock sales. This decision was particularly surprising given Buffett's previous statements about Apple being a "forever stock" for Berkshire. The sale triggered a sharp drop in Apple's stock price, which had already been under pressure due to slowing iPhone sales and increasing competition in the tech sector.
We will probably never know whether he wanted to realize profits, cushion the Japan drop, get back in at more favorable conditions or increase his liquidity with a profit from one of the portfolio top performers in order to be ready for massive additional purchases. What we do know is one of his Credos: Be greedy when others are fearful.
Cash Hoarding: In addition to selling Apple stock, Buffett has been hoarding cash at unprecedented levels. As of the latest filings, Berkshire Hathaway's cash reserves have swelled to over $300 billion, the highest in the company's history. He now holds more T-Bills than the Federal Reserve (https://markets.businessinsider.com/news/bonds/warren-buffett-owns-more-t-bills-yields-federal-reserve-berkshire-2024-8?op=1). Buffett's actions suggest a deepening concern about the market's valuation and the broader economic environment and can be triggers for investor sentiment as Buffett's actions often serve as a bellwether for broader market trends. Historically, Buffett has hoarded cash in times of uncertainty, waiting for opportunities to buy undervalued assets during market downturns.
The Fundamental Economic Landscape
The fundamental economic data since August 5th has continued to reflect a challenging environment:
Inflation Stubbornness: Inflationary pressures remain persistent across major economies, with core inflation staying above central banks' target levels. This has complicated monetary policy decisions, as central banks are caught between the need to tame inflation and the risk of stifling already weak growth.
Corporate Earnings Deterioration: The Q2 earnings season has revealed broader weaknesses in corporate America. Beyond tech, sectors like consumer goods, financials, and industrials have reported average or disappointing results, with many companies revising their guidance downward for the rest of the year. Margins are being squeezed by rising input costs, and consumer demand is showing signs of softening even in areas that have been strong bedrocks for investors like Beverage and Fast Food companies (i.e. Diageo or McDonald’s).
Consumer Confidence Wanes: Consumer confidence has continued to erode, with surveys indicating growing pessimism about the economic outlook. High inflation, rising interest rates, and a weakening labor market are all contributing to a more cautious consumer base, which in turn is impacting retail sales and broader economic activity.
Global Trade Weakness: Trade data from key economies has shown a marked slowdown, with exports and imports both declining. Germany’s GDP Growth doesn’t look too appealing either. The ongoing trade tensions, particularly between the US and China, are exacerbating these trends, contributing to the global economic malaise.
Our Two Cents
The stock market crash of early August 2024 appears to be more than just a fleeting disruption; it may be the harbinger of a prolonged period of volatility and economic instability. The ongoing struggles of the Japanese Nikkei, the pronounced fluctuations in U.S. markets, Warren Buffett's unprecedented strategic pivot, and the deteriorating global economic fundamentals all signal that we may be on the brink of something far more severe if policy makers continue their current path.
As inflation remains stubbornly high, growth stalls, and geopolitical tensions mount, the market outlook is becoming increasingly bleak. The sharp decline in consumer confidence and the weakening of corporate earnings suggest that the economy may be teetering on the edge of a recession, if not already in one. Global trade is faltering, and the bond market is flashing unmistakable warnings with an inverted yield curve and high volatility.
Warren Buffett's actions, including the massive sale of Apple stock and the unprecedented hoarding of cash, could be seen as a stark warning that even the most resilient market leaders are bracing for further downturns. His moves suggest a deepening concern that the market could be headed for a prolonged correction, or worse, a significant economic downturn.
In this environment, investors might be wise to approach the market with heightened caution. The risks of further declines appear substantial, and the potential for a swift recovery seems increasingly remote.
Our view can change in a heartbeat if strong and wise policy action occurs, but inflation outlooks suggest that the window of opportunity has already faded.
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