$6.4 Trillion Market Plunge Sparks Fears of Prolonged Downturn Amid Volatility

On August 5, global stock markets faced dramatic drops, with the Nikkei falling 12%, the Kospi 9%, and the Nasdaq plunging 6% at the opening bell, raising concerns about a prolonged downturn.

Global Markets Plunge as Investors Flock to Safe Assets Amid Volatility and Recession Fears

On August 5, market veterans were stunned by dramatic drops across global stock markets. The Nikkei fell 12% in Tokyo, the Kospi dropped 9% in Seoul, and the Nasdaq plunged 6% at the opening bell in New York. The VIX, a measure of market volatility, surged, and cryptocurrency values plummeted, prompting investors to flock to Treasury bonds, considered the safest assets.

The market turmoil raises questions about whether this marks the peak of a global selloff that began the previous week or the start of a prolonged downturn. While the Nikkei rebounded by over 10% the following day, and U.S. stock futures showed slight gains, the underlying assumptions that have driven market growth for years have been challenged. Recent evidence has undermined the belief in the unstoppable growth of the U.S. economy, the rapid transformation by artificial intelligence, and Japan's stable interest rates.

The July U.S. employment report and the quarterly earnings of Big Tech companies propelled by AI were disappointing. Additionally, the Bank of Japan raised interest rates for the second time this year. This confluence of factors jolted investors into realizing the risks of overvalued assets, such as Nvidia shares, junk-rated loans, and high-yield investments. Over the past three weeks, global stock markets have lost approximately $6.4 trillion.

Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore, described the situation as "the great unwind," likening it to trying to catch a falling knife. The panic has generated significant hazards, potentially disrupting the financial system and stalling lending, which could push the global economy into a recession.

Calls have emerged for the Federal Reserve to reduce interest rates, possibly before the next scheduled policy meeting in September. Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment, argued that the Fed should ease if financial conditions deteriorate, especially in credit market liquidity. Other market observers echoed this sentiment, noting the yield curve's disinversion as a recession warning.

A seasoned market economist, Ed Yardeni, compared the abrupt market collapse to Black Monday in 1987 but suggested it might not signal an economic calamity. He pointed out that while it was alarming, it didn't result in a recession then and might not.

Throughout the current bull market, premature recession concerns have caused volatility. The brief banking crisis early last year and the significant stock market decline in 2022 quickly dissipated as the U.S. economy thrived. However, the recent shift in global sentiment has disrupted the usual late-summer calm, affecting vacation plans and trader strategies.

Market Turmoil Forces Strategist to Cancel Vacation as Global Selloff Intensifies Amid Economic Fears

Matt Maley, chief market strategist at Miller Tabak + Co., experienced a sense of déjà vu on August 5, recalling the shock of 1987. As the market turmoil unfolded, he canceled his vacation plans and returned to his London apartment to manage the situation.

The forces precipitating the unrest on August 5 had been accumulating for weeks. In early July, the Japanese yen's significant rise coincided with the peak of tech equities, as investors anticipated the Bank of Japan reducing its monetary stimulus. According to Bloomberg, this led traders to unwind carry trades, resulting in global selling pressure. Earnings reports from major tech companies like Intel and Amazon fueled concerns that their stocks had risen too much without realizing profits from AI investments.

The bond market's escalating concerns and data indicating economic slowdown compounded the situation. Bond prices had risen when the Federal Reserve maintained high rates, and the Bank of Japan tightened policy, leading to additional gains as job growth fell below expectations.

Wall Street economists began predicting that the Federal Reserve might need to intervene with substantial rate cuts or act between meetings, typically a crisis measure. Shoki Omori, chief desk strategist at Mizuho Securities Co. in Tokyo, was surprised by the extent of the selloff on August 5 despite anticipating significant market fluctuations.

The Nikkei's persistent decline throughout the session, driven by the yen's 3% rise due to BOJ rate hikes, led investors to pull out of Japanese stocks, fearing a negative impact on export-oriented companies. The Nikkei ended the day with its most significant drop since 1987.

The market losses spread to other Asian markets, Europe, and the Americas. The credit markets were also affected, with at least two companies postponing loan agreements worth $3.8 billion. By late afternoon in the U.S., the Nasdaq Composite Index had declined by 3.4%, while the bond market stabilized, and stocks recovered from their lows.

Despite the recovery, traders remained concerned about earnings and the economy. Maley, reflecting the sentiment of many, expressed ongoing worries about the market's future stability.