Markets Are Getting Skittish

A wave of selling hit markets last week as the risk-off trade intensified.

The speculative end of the market was hardest hit, with cryptocurrencies in the crossfire. By Friday’s close, Bitcoin and Ethereum had crashed 33% and 44% from their respective peaks.

Even the AI trade’s leading stock, Nvidia (NVDA), got pulled into the sell-off. It initially jumped off the back of its big earnings beat, but NVDA closed 8% below where it opened.

Whichever way you slice it, things look scary. Valuations are stretched, markets are skittish, and the economy is looking iffy.

So investors need to prepare themselves for volatility ahead. Let’s look at what the catalysts could be…

Changing Rate Expectations

One of the reasons behind the sell-off was increasing skepticism around stock valuations. Will companies be able to convert their AI spending into profit?

Adding weight to the sell-off was the changing narrative around interest rates.

When the Federal Reserve cut rates by 0.25% in October, markets were fully factoring in another 0.25% cut in December. That expectancy was tracking above the 90% level.

Yet those odds fell sharply last week when minutes from the Fed’s last meeting came out…

The majority of officials expect rates to fall over time, but there is clear disagreement on timing. A number of people fear that the fight against inflation has stalled. A potential majority of officials could oppose a December cut.

And those odds only worsened with the release of employment data on Thursday.

Unemployment rose slightly (up 0.1% to 4.4%). Yet September’s nonfarm payrolls (NFP) data surprised to the upside, with the number of new jobs coming in at 119,000. That saw rate cut expectations slip to just 34%.

Then things took another turn…

Up in the Air

In a speech last Friday, New York Fed President John Williams noted that current rate settings were “restrictive.” He said that rates could fall in the near term without fueling inflation.

That was enough for rate cut expectations to jump near 70%.

Yet despite heightened expectations, a rate cut is no certainty. There’s too much dissent within the walls of the Fed and little data. What’s more, the next batch of inflation data won’t come out until after the Fed’s meeting and its interest rate decision.

Speculation is going to intensify between now and then. That’s going to cause volatility to ratchet higher over the coming weeks…

So far, we haven’t seen any panic selling in stocks – although we finally witnessed some of that when Bitcoin broke down through $90,000.

That could quickly change if stocks fall another 5%. Given that folks couldn’t even handle a 1–2% fall, a bigger drop could see them hit the panic button.

In the meantime, we’ll patiently wait on the sidelines for markets to overshoot in either direction. We’ll put our mean reversion strategy into action to bank some quick profits.

Market sentiment has clearly changed. Things are looking shaky. And that’s when traders can get to work.

Happy Trading,

Larry Benedict