But this summer’s crash will also be remembered as a particularly extreme example of a trend that has shaped modern finance in recent years: the increasing frequency of shocks that occur with little warning.
As quickly as volatility spiked, it has subsided as the S&P 500 notched its biggest weekly gain since November, junk bonds notched a one-week gain and Treasury yields stabilized. In a particularly vivid example, the VIX index, Wall Street’s “fear gauge,” just broke two records: the fastest ever spike of 25 points or more and the fastest recovery from a spike, according to UBS Group AG.
The reversal is a nightmare for anyone trying to rationalize market movements. Was the trigger for August’s selloff technical or something more sinister, like a Federal Reserve policy misstep or fears of a coming AI meltdown? Whatever your perspective, frenzied markets, driven by interconnected swarms of leveraged traders, periodically swing from euphoria to despair and back just as quickly.
BloombergIndeed, the increasing frequency of price spikes has been a growing area of financial research since at least 2019. Strategists at Bank of America have coined the term “fragility” to describe events that have become five times more frequent than they were in the last century. Vulnerabilities include the fear of a Chinese devaluation in 2015, the trauma of Volmageddon in 2018 and the coronavirus crash.
“The extreme market ups and downs of the past few weeks are the latest example of how inherently fragile markets have become over the past 15 years,” said Nitin Saxena, head of U.S. equity derivatives research at Bank of America. “The speed with which the shock dissipated only strengthens our confidence that, due to its technical nature, rapid mean reversion is a hallmark of fragility shocks. A more fundamental shock would have more staying power.”
Previous crashes have included overcrowding and liquidity instability, both of which were evident in 2024, when a handful of artificial intelligence (AI)-powered super stocks dominated index returns while the majority of the stock market fell into near-favor. Vulnerabilities became apparent when the rapid unwinding of popular positions, including the yen carry trade, spread rapidly across borders and turned into market-wide dislocation.
That such a wide range of assets were caught up in the turmoil supports Saxena’s view that something is at fault in the nature of the markets themselves: Bitcoin, the Swiss franc, investment-grade bonds, copper, and Japan’s Nikkei stock average have all been hit hard, he says, and are a lesson in “how pervasive vulnerabilities are across markets, and how markets can become dysfunctional in times of stress due to extreme supply-demand imbalances.”
BloombergMany systematic funds slashed their exposure to stocks last week, shutting out the quants who track market trades. By some estimates, three-quarters of the world’s carry trades had been unwound by Wednesday, only for corporate clients and hedge funds to rush back a few days later.
“A unique set of circumstances occurred where a combination of positioning, pricing of risk, levels of volatility and market liquidity aligned in a way that challenged what had been working all year,” said Ashish Shah, chief investment officer of public investing at Goldman Sachs Asset Management. “And the positioning around these themes just completely fell apart.”
The week then saw stocks, bonds and credit rise in unison in the biggest coordinated rally of 2024, according to data compiled by Bloomberg that tracks popular ETFs. The S&P 500 posted its best weekly gain this year, 3.9%, snapping a four-week streak of losses. The world’s largest government bond exchange-traded fund rose about 1%, with investment-grade and junk bonds also rising. Gold rose to $2,500 for the first time. The VIX fell below 15 after climbing above 65 during the turmoil.
BloombergTraders have been recalibrating their Fed bets after a recent string of data showed reassuring signs on inflation. The producer price index, for example, rose less than expected earlier this week. Swaps traders are still pricing in nearly a percentage point of Fed easing in 2024, with the market poised for its first rate cut in September. Attention is focused on the Jackson Hole Symposium for clues about how Chairman Jerome Powell views the economy.
“We used to only be focused on the Fed and interest rates and inflation, and now we’re only focused on corporate earnings and slowing growth and volatility,” Caterina Simonetti, senior vice president at Morgan Stanley Wealth Management, said on Bloomberg TV. “It’s very confusing for investors who tend to rely on short-term memory.”
All 11 major sectors rose in unison this week as the bond market continued to warn of economic weakness. With the Federal Reserve preparing to cut interest rates to stave off the expansion, investors are once again worried about missing out on gains in riskier areas and are unwinding hedges they bought weeks ago.
With the possibility of sentiment turning euphoric again in the coming days, the chances of another market turmoil are growing. Viewed this way, investment professionals, especially those offering a form of portfolio insurance known as tail-risk hedging, argue that markets are more vulnerable than ever before, due to herd behavior, questionable liquidity and an increase in volatility-sensitive investors who trade on technical rather than economic triggers.
“Like any other market near a top, we’re in a zone where we’re constantly hitting new highs,” said Josh Kutin, head of North American asset allocation at Columbia Threadneedle Investments. “That makes the market more vulnerable. It creates an atmosphere where people are more easily scared.”
