190430 Nasdaq
The Nasdaq 100 surged 2.4% on Wednesday when the Fed announced a faster end to its programme of economic stimulus and signaled two rate hikes next year, only to wipe out the entire gain the next session. Image Credit: Bloomberg

Down one day, up the next, the stock market is making life miserable for anyone in search of a coherent narrative to explain its moves. One thing has stuck, though: Episodes of daily upheaval are worsening.

Particularly at the speculative end, the trend is pronounced. In the Nasdaq 100, the absolute size of close-to-close moves has been roughly 1.5 per cent a day this month, up or down. That’s three times as great as any December since the Christmas rout of 2018 and almost twice the average move of the last year.

While many forces are at play - witness all the evidence of the fast-spreading Omicron variant on Friday - it’s hard not to notice volatility is picking up at a time when the promise of unending central bank liquidity is in jeopardy. The Federal Reserve is ramping up hawkishness while the Bank of England raised interest rates, marking the end to an easing cycle that underpinned a 20-month, $60 trillion rally in global equities.

“The market has spent the last few weeks digesting the likelihood of an accelerated taper schedule, beginning with a contraction in software multiples throughout earnings season despite strong operating results and relatively strong guidance,” said Renny Zucker, chief investment officer at Capital Y Management. The rising volatility “is a reminder that Fed action in the coming year could be more impactful after nearly two years of fearless trading in the riskiest of risk assets”.

Big reversals played out over the week as investors tried to get a grip on whether Fed chair Jerome Powell will be able to engineer a soft landing by taming inflation without choking off growth. While investors initially took solace in Powell’s robust endorsement of the economy, characterising demand and income as strong, a sense of uneasiness sank in later with a drop in long-dated Treasury yields reviving worries over its continued strength.

The Nasdaq 100 surged 2.4 per cent on Wednesday when the Fed announced a faster end to its programme of economic stimulus and signaled two rate hikes next year, only to wipe out the entire gain the next session. All told, tech-heavy gauge dropped more than 3 per cent over five days for one of the worst weeks this year.

The smooth ride that has been the signature of this bull market is at risk. The Nasdaq 100 has posted five daily moves of at least 2 per cent over the past three weeks - three up and two down. That matched the total number of comparably wild sessions in the previous five months.

Big flip-flops reflect an elevated level of confusion among market participants, according to Mike Zigmont, head of research and trading at Harvest Volatility Management.

Conflicting narratives abound. While strategists at Credit Suisse Group AG point to history and say it’s safe to buy stocks during the initial stage of a tightening cycle, their counterparts at Bank of America Corp. warn this time could be different as inflation is out of control.

“I don’t have conviction. And I think a lot of investors are like that,” Zigmont said. “They look at the world and they have a view, but it’s not a powerful view. Without conviction, but with a lot of trend following, you can get this whippiness that we’ve seen.”

In speculative corners of the market, the ride has become bumpier. Over the past few weeks, the Russell 2000 of small-caps fell into a 10 per cent correction, newly minted shares sank into a bear-market decline of 20% per cent, and a group of profitless technology firms plunged almost 30 per cent.

While the Russell 3000 Index is up 20 per cent this year, the median stock is down 21 per cent from the recent peak. Such a wide divergence reflects “a historically unprecedented overshoot” in selling smaller and more volatile stocks - economically sensitive shares in particular - that was mostly driven by hedge funds stepping up bearish bets while cutting back on their risk exposure, according to JPMorgan Chase & Co. strategists led by Marko Kolanovic.

All the bearishness likely sets the stage for a rebound into the New Year, when the pandemic comes to an end and the economy keeps expanding, Kolanovic says. “This market episode may end up in a short squeeze and cyclical rally into year-end and January,” he wrote in a note on Friday.

Not everyone is convinced the reflation trade will soon return. With the economic path uncertain, investors sought safety in firms with stable income and dividends. Over the week, a MSCI measure of defensive shares such as utilities and consumer staples climbed 1.2 per cent, compared with a loss of 2.9 per cent for cyclical shares. The performance gap was the widest since April 2020.

To Ella Hoxha, senior investment manager at Pictet Asset Management, the disagreement reflects a harsh reality - the unorthodox post-pandemic recovery remains murky.

“If you’re a believer we’re late in the cycle, you will probably err more towards the side of the Fed making a policy error, or tightening potentially too much,” she said in an interview on Bloomberg TV with Lisa Abramowicz. “If you’re in the early-cycle believer camp, then it’s a very typical type of behavior to see as we start to tighten policy. It’s very much where you sit within the debate conundrum.”