Why so down, S&P 500?

This is an audio transcript of the Unhedged podcast episode: ‘Why so down, S&P 500?’

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Ethan Wu
Remember last week’s massive 4.9 per cent US GDP number? Well, stocks don’t like it. The S&P 500 has officially entered correction territory, down more than 10 per cent from the peak on July 31st. It’s weird. It’s a strange combination of hot growth and falling markets. Today on the show, we discuss why stocks are feeling so bothered in this hot economy. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. It is Tuesday, October 31st 2023. I’m reporter Ethan Wu here in the New York studio, joined by markets editor Katie Martin to describe the spooky Halloween we are having in markets.

Katie Martin
Terrifying times, Ethan.

Ethan Wu
But I feel like you’re dressed for it. Katie, I know this is not a visual medium, but Katie is wearing a scarf adorned with orange tassels.

Katie Martin
And a black dress. I’m as scary as I get right here.

Ethan Wu
(Laughter) Well, speaking of scary, let me read you some of the things that are coming into my inbox from the markets and econ research world, OK? These will really frighten you. From Ned Davis Research: is a 7 per cent 10-year Treasury possible?

Katie Martin
What?

Ethan Wu
Longview Economics: from a price action perspective, most parts of the US equity market are consistent with an economy that’s about to roll into recession. Morgan Stanley: risky markets trade as if the current level of risk-free rates is too high to handle. I’m panicked, Katie. I’m having a panic attack.

Katie Martin
Are you gonna dress as the S&P 500 when you go trick or treating this evening?

Ethan Wu
(Laughter) A colleague actually recommended I dress as the yield curve and I asked what that meant. And she just, like, bent her body like in an arc with your hands forward.

Katie Martin
Niche.

Ethan Wu
(Laughter) Anyway, I think broadly we can break down what’s going on in markets into three categories, Katie: valuations, recession and rates. Why don’t we start with valuations?

Katie Martin
Well, why don’t we start with, you know, what is not eating stocks? If you had said to me at the start of the year we will have two banking crises and two actual wars and five percentage points of Fed rate rises to deal with. What will stocks do in the US this year? I would not have said don’t worry about it, Ethan. They’re gonna be up 8.5 per cent by Halloween. No, sir. So, you know, this is one of the things that investors are talking about a lot at the moment, which is, yes, this environment is pretty grim, but it could be a hell of a lot worse based on the kind of news flow that we’re seeing. So, you know, there’s a lot going on there.

But yeah, it has all gone, as we Brits say, a little bit Pete Tong over the past . . . (Ethan laughs) What? Just Google it. Just trust me. Trust me on this. Google it. It’s all gone a bit Pete Tong in the markets, it’s all gone a bit wrong. The S&P, as you say, is down 10 per cent from its peak in July. And yeah, valuations are a decent part of that right? You know, you can’t get away from the fact that we’ve had an extraordinary start to the year, like a massive run-up, particularly in US stocks, and it’s all just unravelling a bit.

Ethan Wu
I think that is the right point to make. A correction can still leave stock markets in a pretty decent shape when you zoom out and take the bigger picture. But I do think, you know, one of the bend to move it to the valuations point, the big swing factor has been Big Tech and that they’re both responsible for a lot of the upside earlier this year and now also a lot of the downside. Our colleague Nick Megaw had a great piece in the in the FT just a couple of days ago making the point that not just in US markets but in global equity markets, Big Tech make up all of the year’s gains. It’s like a truly extraordinary fact that like seven companies, all household names everyone knows, are making up all of the gains in all stocks everywhere. It’s really just, it’s incredible.

Katie Martin
Yeah. And the kind of, you know, the pointy fingers crew at the start of the year who were saying, well, you know this, I’m pointing my fingers. Not that you can see listeners, but you know well, you know, if you’ve only got seven stocks that are doing all the heavy lifting, pulling the markets up at the start of the year, then you only need one of those seven to get in trouble. And what do you know, you’ve got trouble?

So, for example, shares in Google owner Alphabet fell 10 per cent last week because there was a narrow revenue loss on like one division. So a little bit of a kind of miss and that just gets absolutely punished by the market. So what we’re seeing now is particularly but not only but particularly for the really high-value stocks now, investors are just not having any of your nonsense. So to contrast that, there was a nice beat from Microsoft around the same period in the markets like, meh. So stocks are taking a bath when something goes wrong and they’re not doing very much on the upside if companies report something a bit rosier. And that does illustrate the shift in mood that we’re seeing.

Ethan Wu
I do want to emphasise the kind of asymmetry you brought up, Katie, that markets are punishing small misses very heavily and rewarding reasonably large outperformances on earnings by not that much. Google’s earnings were fine if you take them in the big picture, right? The company’s revenues are up 11 per cent year over year. Profits are up. Margins are expanding. But in the cloud division, which is where kind of all the attention is focused on a lot of Big Tech earnings, especially for Amazon, Microsoft and Google, they decelerated a bit quarter over quarter and sales still up over 20 per cent but decelerating. And that was enough to knock a really big chunk of Alphabet stock.

Katie Martin
It’s like, what do you want, blood? You know, like one tiny little mistake. But yeah, I think it was while you were off, Ethan, I was talking to Rob Armstrong about all the stock market debuts that were coming through. There was this big resurgence in IPOs and, oh, isn’t it fantastic? We’ve got all these shiny new companies on the stock markets. They’ve all been, like, annihilated. (Laughter) So, yeah, you know, all these kind of new listings, if you look at Klaviyo, Instacart, Birkenstocks — you know I love my Birkies — but all these kind of new IPO stocks have been having a rough time. Any stock that comes from a company that’s announced something even slightly squidgy in its earnings is having a bad time. It’s tough out there, it’s a lot tougher out there in the stock market than it was a few weeks ago.

Ethan Wu
And I think it’s so hard to talk about valuations in the stock market punishing even relatively good earnings without talking about where interest rates are. You can earn, in inflation adjusted terms, 2 to 3 per cent on a long-dated Treasury. You can earn a similar amount going into cash totally risk-free. If you wanna take on more risk there are options in corporate credit, in high-yield bonds and elsewhere that offer 8, 9, 10 per cent. These are competitive returns with equities with arguably a fraction of the risk and potentially less rate exposure.

Katie Martin
Very, very arguably on the high-yield side, but certainly on the kind of rates and cash side. I mean, sure, this is a big problem that a lot of investment managers have got now. Is it how do you convince clients to put money to work in the stock market when they’re like, I’m good, actually, I’ve got a little deposit account over here, got it in cash. Why would I bother taking the risk? So this kind of hurdle, this idea that stocks just, you know, have to compete now for a place in all of our hearts and all of our portfolios, this is gonna hang over the market for a long time.

Ethan Wu
Yeah. And that brings us into a discussion of the rates environment in general. I mean, the big story, it’s been the 10-year Treasury, it’s been the yield hurtling as fast as possible to 5 per cent in the past month or two. And I think the giant run-up in the long yield doesn’t necessarily, it doesn’t feel settled to me, I suppose. And there’s a lot of focus this week on there’s a big auction of Treasuries on Wednesday that could, you know, give us some indication of how much appetite there is for market participants to buy up those Treasuries. The point there being that we don’t really know where long yields are going to end up at the end of the day.

Katie Martin
No. And this is all part of the kind of massive recalibration that’s going on across every different asset class around the world, which is, you know, again, we have spoken about this a lot, but it’s a big deal, this shift to higher for longer, this shift to acceptance that central banks are not going to pull interest rates up to the sky and then just drop them again. They’re gonna stay there. These rates are gonna stay high for a long time. That’s the messaging that they’re pushing across now. And what we’re seeing on the bond side of the market is this realisation really sinking in, which is why you’ve got yields shooting higher. The second-round effect of that almost is that it pulls equities down because again, why bother? Why get into equities If you can earn that much in your super-safe fixed income bit of your portfolio?

Ethan Wu
It feels to me like since the market peak, what has changed is markets have started believing what the Fed’s been saying for the better part of a year now.

Katie Martin
I know, which I find just bizarre like . . . 

Ethan Wu
But you can see this in the data. July 31st is the peak in the S&P 500 that coincides with the 10-year yield shooting up again. It coincides with the kind of flattening out at a high peak of interest rate expectations for this year. It coincides with kind of the greatest flow of strong data surprises. So the US economy surprising to the upside, which would have to tempt interest rates higher, potentially, or higher for longer. And all those things sort of coincide at around the market peak in late July or early August. To me, that just paints a picture of eventually there was just enough evidence to sort of push the market psychology over the hump to believing, OK, this is for real, this might actually happen.

Katie Martin
It’s vibes, man.

Ethan Wu
It is, or we call it sentiment, Katie, it’s called sentiment.

Katie Martin
I’m so down with the kids, though, that I’m gonna call it vibes. (Laughter)

Ethan Wu
Well, I think the vibes are shifting and nowhere is that clearer than in the third component of the sell off, which is slowdown/recession, which feels to me like insane to talk about. But like I was reading this out earlier from Longview Economics, it’s in the discourse again, people are talking about the price action we’re seeing in markets being consistent with the economy rolling over. What’s all this about, Katie?

Katie Martin
I don’t know. Is it a little bit of kind of desperation? You know, there are some analysts that I speak to that say I’ve got a recession call baked in. I truly believe this is gonna happen. I do not think that you can have five percentage points of rate rises and a banking crisis and a series of wars around the world without that being bad for growth. You know, I just feel that there’s a recession coming through. But they’re a little bit embarrassed to talk to their clients about that because they’ve been saying this all year and it’s just not happened. So I’m not saying it’s wrong. I mean, I don’t know. I don’t have perfect view of the future. But I just think that there is you know, we’re at that point in the year when people are starting to put out their kind of big, thunderous, you know, here’s our views for 2024. And people do still believe in this. And so, as you say, it’s like, it’s bubbling back up in the inbox all over again. Doesn’t make it true. Hard to say.

Ethan Wu
We talked last week about the 4.9 per cent real GDP print for the third quarter this year.

Katie Martin
How about that! Go USA!

Ethan Wu
It’s really exceptional. Some people rushed to point out that before the 2008 financial crisis, we had a very identical-looking GDP number, about 4.9 per cent, just a couple of quarters before the entire economy plunged into one of the worst recessions in decades. Now, I don’t think anyone is making a prediction of 2008-like recession or financial crisis dynamics. But I think the point is that the economy can roll over quickly. The unemployment rate has a tendency to shoot up very late. GDP can swing dramatically because of changes in things like inventories or trade balance or whatever. Like, the economy being at 5 per cent today does not guarantee it’ll be 5 per cent tomorrow, in other words.

Katie Martin
But at the same time, once again, one more time with feeling, higher for longer. The Fed, unless they have, I don’t know, unless someone put something in their tea, they are not going to switch on the message that they have been really hammering through lightly. We’re not gonna see rates just kind of pulled back down to the floor at the slightest hint of trouble. So in a way, it’s kind of, good news on the economy is bad news for stocks because it means that rates are going to start to stay higher. Bad news on the economy is probably even worse for stocks because rates are gonna stay higher. So you kind of can’t win. And that’s the kind of mood right now. Yes, it could change for any number of reasons, but the investors have got their sad face on at the moment.

Ethan Wu
Well, Katie, we’ve run through three potential explanations for the sell-off with a correction in stocks: valuations, recession/slowdown and rates. Which of these do you find the most convincing? Which do you think has been the most important in the sell-off so far?

Katie Martin
My favourite. For all that it matters is around valuations. I think what it tells you is that this kind of very fizzy market that we had at the start of the year, lots of AI excitement, you know, this massive run-up in a small clutch of US stocks. It felt overdone at the time. It really feels overdone now. So I just feel like it’s not so much that the markets are behaving super strangely now. It’s that they were behaving super strangely before, and I think they just got a little bit overexcited. That’s, I mean, for what it’s worth, that’s my take.

Ethan Wu
That’s a good point. No, I mean, everyone at the beginning of the year was saying this is unsustainable. This is unsustainable. And now it’s, you know, this is what you would expect if you . . . 

Katie Martin
(Laughter) Guess what? It’s unstable.

Ethan Wu
Yeah. I hear your point on valuations. I guess I would just maybe throw some weight behind a rates and Fed-driven explanation of this, you know, to your point earlier about higher for longer being kind of what really matters here. And to me higher for longer is like fundamentally about inflation, right? It’s like, why is the Fed keeping interest rates higher for longer? Well, because wage growth is still strong, because inflation has firmed up a bit in the last couple of months of inflation data. And until that convincingly, convincingly rolls over the Fed has to maintain this position, at least directionally, of being pretty damn aggressive on interest rates.

Now, that could all change very quickly. Like, I think it just takes a couple of convincing inflation reports below 3 per cent to get the Fed to move on this. But because we’re not seeing that and because I think stronger growth has a scary feeling for the Fed in that it suggests that inflation may not rollover in such an orderly way. I mean, I think that’s the main thing kind of locking the Fed into its current course of action, which keeps markets feeling on edge. So in other words, if we get optimistic inflation news in the next couple of months or early next year, which is totally possible, I think a big relief rally could be coming. But that has to happen in the data. And until that happens, I don’t know what the relief is for markets.

Katie Martin
Yeah. Show me the money. Yeah.

Ethan Wu
Yeah, exactly.

Katie Martin
Do you remember happy days before people, you know, when people talked about things other than inflation? (Laughter) Like, it’s just, you can’t get away from it. It’s just, it rules everything around it.

Ethan Wu
Katie, I think one casualty of this job is I barely remember what happened yesterday. (Katie laughs).

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There’s a memory-eliminating quality to to watching markets so up close and personal. All right, Katie, we’ll be back in a moment with Long/Short.

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This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Katie, I am long Fred, a very generous listener who wrote in after we discussed your van collision last week to wish you well and to give you some advice on how to avoid such collisions in the future. Fred writes in his email: “Hi, Katie. Obviously, the route you travel is a major risk factor. The backstreet routes with low traffic volumes aren’t obvious and general mapping apps — hello, Google — do not suggest good routes. So it’s worth double checking using the best ones”. He runs through several apps and local cycling Facebook groups that you can join. He adds, “Finally, I can’t write this without mentioning safety around lorries, turning left where they can see you, etc as that’s especially important and worth taking extra care”.

Katie Martin
That’s very sweet. That’s very sweet. Thank you, Fred. For what it’s worth, I’ve just decided, I think, to just, like, give it a rest for a month and then see how I feel. But I’m quite bored of getting knocked off my bike when it’s not my fault. If it was my fault, I would kind of maybe even accept it a bit. But yeah, maybe I’ll just give it a bit of a rest and then see if the whole thing is a good idea or not.

Ethan Wu
Bored is one word you could use to describe that.

Katie Martin
Yes.

Ethan Wu
Katie, do you have a listener-related long?

Katie Martin
I kind of do, actually. I am currently long Ireland. I was there last weekend at a delightful wedding and I’m going next weekend for Kilkenomics, which is a weird-sounding festival which combines comedy and economics and market stuff. And it’s very good fun. But anyway, while I was at a wedding in Ireland last weekend, some listeners were right there. Zoe and Nick, hello. And they were saying how much they enjoy listening to the show and listening to our little bits of banter. So it’s always a little bit kind of weird, but also quite charming when you come across people in real life who listen to our mutterings on a podcast. (Both laugh) Yeah, people kind of feel like they know you, which is nice.

Ethan Wu
It really is. Listeners, we love hearing from you. And it wasn’t just Fred who wrote in nice emails about Katie’s bike accident. We got four or five emails. Very kind and generous listeners who wrote in. We love hearing from you. Please write in any time — suggestions, feedback, criticism, biking advice — ethan.wu@ft.com.

All right, Katie, thanks for being here and we’ll have you back on the show next week and listeners, we’ll be back in your feed on Thursday with another episode of Unhedged. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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