Uncertainty increases in the US stock market as stocks are teetering on the edge of their most challenging October in the past five years. The volatility index VIX is hovering around 20.
The CBOE Volatility Index, often called Wall Street’s “fear gauge,” remained above 20 for a second consecutive week. That’s a significant departure from its previous state of staying below this threshold for over 100 days.
Furthermore, bond market volatility added another layer of concern, with significant fluctuations of over 10 basis points observed on Wednesday and Thursday.
The bond market seems to be in ongoing agitation, oscillating between unpredictable moves.
These disturbances in the financial landscape are testing the resolve of even the most ardent equity bulls. Those conditioned to seize opportunities during stock market weakness also pass through toughness.
Amid this growing unease, investors from various categories are beginning to exhibit a defensive stance. A posture that has become more pronounced than it has been in over a year.
The volatility and market dynamics continue to confound and challenge traditional strategies and expectations. All these factors create an evident sense of apprehension within the investment community.
Signs of Recovery or Prolonged Uncertainty?
Professional managers overseeing significant capital have significantly reduced their equity holdings, reminiscent of the depths of the 2022 bearish stock market.
This trend is further underscored by the continuous increase in single-stock short positions by hedge funds. This has now persisted for an 11th consecutive week.
Moreover, various models assessing investor positioning reveal a consistent pattern across the board. Mutual funds, as well as systematic quantitative traders, are scaling back their equity exposure to levels well below long-term averages.
Market timing is often criticized as a trading sin, but it remains a temptation, especially during stock market turmoil.
The current investors’ behaviour raises a significant question as we approach November- Is this withdrawal a sign of an impending market rebound or a potentially prolonged period of financial uncertainty and volatility?
Doug Ramsey, the Chief Investment Officer at the Leuthold Group, expresses concern that the current significant stock market setback hasn’t led to a more positive shift in sentiment among investors.
He observes that the persistent worries that have characterized much of the 2023 market activity have evolved into a more cautious and hesitant stance. He aptly describes the scenario as a “slope of hope.”
October Turbulence, tech sector struggles, and market direction amidst rising yields
Dip buyers have become scarce, as the S&P 500 experienced over five separate declines of more than 1% throughout October.
Notably, a measure of expected price volatility in the Nasdaq 100 Index has remained elevated.
Even though the tech sector received a boost on Friday due to strong earnings reports from Amazon.com Inc. and Intel Corp., the Nasdaq 100 concluded its worst two-week decline in the current year and is on track for its most significant October loss since 2018.
Matt Maley, the Chief Market Strategist at Miller Tabak & Co., notes that with yields significantly higher than they were just six months ago, it’s becoming increasingly likely that the stock market will need a correction to align with historical valuation norms.
A contrarian perspective interprets prevailing market pessimism as a positive sign, hinting at untapped buying potential when sentiment changes.
Some strategists expect such a shift, noting that past equity reversals are closely correlated with changes in institutional and retail investor positions.
Historical data shows that market gains often followed reduced bullish positions while buying frenzies led to declines.
Thus, it emphasizes the role of sentiment and positioning in stock market direction.
Predicting market turning points is complex. Investors face uncertainty due to the Federal Reserve’s extended interest rate stance and persistent inflation.
The accelerated reduction of the Fed’s government securities portfolio adds more uncertainty.
Expert Insights on the stock market
Barclays strategists highlight factors promoting a potential year-end rally, such as reduced stock exposure, positive technical signals, and seasonal trends.
This perspective resonates with Bank of America Corp. and Deutsche Bank AG.
Callie Cox from eToro emphasizes that fear, while uncomfortable, can be a positive stock market influence.
When investors anticipate adversity, they are less prone to panic selling during negative news, contributing to a steadier and more resilient market environment.
Peter van Dooijeweert, head of defensive and tactical alpha at Man Group, suggests that the Fed’s extended interest rate policy and inflation indicators will keep the bond market unstable.
This turbulence could negatively affect equities, especially if corporate earnings disappoint. It emphasizes the complex interactions shaping financial markets.