Behind the "sharp drop and sharp rise" of the US stock market: Greed temporarily defeats fear, and the market is becoming increasingly fragile

In Wall Street, the game of greed and fear never stops. In recent weeks, the global stock markets have experienced a roller-coaster ride of "sharp drops and sharp rises". Greed seems to have temporarily gained the upper hand in this game. This week, the S&P 500 index recorded its largest weekly gain since November last year, the junk bond market also saw a long-awaited rise, and bond yields stabilized. All of this seems to imply that market panic has been alleviated. However, this rapid reversal is not without cost. From euphoria to despair, back to euphoria, the U.S. stock market has exposed increasingly serious fragility issues, with volatility becoming the new normal. According to research from Bank of America, the fragility of individual stocks in the U.S. stock market has hit a record high, with the average magnitude of fragility events for the top 50 S&P stocks jumping to the highest level in thirty years. Nitin Saksena, Head of U.S. Equity Derivatives Research at Bank of America, pointed out in a recent report that since 2019, the fragility events in the U.S. stock market have increased fivefold compared to the previous century, including events such as the "Voldemageddon" in 2018 (caused by inflation and rate hike expectations leading to a sharp drop in U.S. stocks) and the collapse triggered by the COVID-19 pandemic. "The extreme market volatility in the past few weeks is the latest evidence of the increasing fragility of the U.S. stock market over the past fifteen years," Saksena wrote, rapid mean reversion is a sign of fragility in the U.S. stock market, where even a small shock can have a more lasting and intense impact. Trading congestion, deteriorating liquidity, and exacerbated systemic selling intensify market fragility Behind the financial market turmoil in 2024, Wall Street has seen issues such as trading congestion and deteriorating liquidity. For example, in the past year, a few AI-driven tech giants have dominated the market, leading to index returns being concentrated in these stocks, while most other stocks have been overlooked by the market. When these mainstream positions (including yen carry trades) are rapidly unwound, turmoil quickly spreads globally, causing trading interruptions across the entire financial market, thus exposing the market's fragility. Saksena believes that under pressure, markets may become generally dysfunctional due to extreme supply-demand imbalances, affecting not only stocks but also assets such as Bitcoin, the Swiss Franc, investment-grade credit, copper, and Japanese stocks, demonstrating the universality of market turmoil and the impact across asset classes. Furthermore, influenced by volatility, a series of systematic hedge funds significantly reduced their exposure to stocks last week, and quantitative funds chasing market trades were squeezed out. It is estimated that by last Wednesday, three-quarters of global arbitrage trades had been unwound. After a series of economic data dispelled recession fears, this week saw the largest synchronized rebound of global assets in 2024, with significant increases in stocks, bonds, and credit: the S&P 500 index achieved its best weekly gain of the year at 3.9%, ending a four-week decline. U.S. Treasury ETFs rose by about 1%, and investment-grade and junk bonds rebounded after a halt Gold has climbed to $2500 per ounce for the first time. The Wall Street "fear index" VIX, which measures stock market volatility, rose by over 65 during the peak of market turbulence and has now fallen below 15. Currently, the market is preparing for the Fed's rate cut in September, with full attention turning to the upcoming Jackson Hole Global Central Bank Annual Meeting next week, where investors will scrutinize Powell's every word and action for clues on the rate cut. Analysts believe that, given the increasingly clear prospect of a Fed rate cut, the sentiment in the US stock market may continue to return to euphoria, leading to a greater chance of a new round of intense volatility. "The US stock market is in a period of continuous record highs," said Josh Kutin, Head of North American Asset Allocation at Columbia Threadneedle Investments, "which makes the market more fragile. It creates an atmosphere where people are more easily frightened."