As stocks mark a 100 percentage-point gain from the start of the artificial-intelligence boom and hit all-time record highs, it might seem churlish to sound the alarm about dangers lurking beneath the surface.
But the recent turmoil tied to the Situational Awareness hedge fund, the worrying upheaval in tech-focused markets in Asia, and the Federal Reserve’s new strategy of policy omerta has some investors worried that markets might be missing the impact of smaller events as they calibrate the odds of a revival of 2008 risks in global markets.
“ ‘Small vol’ events are going to affect markets with an increased frequency,” wrote Deutsche Bank analysts Luke Templeman and Galina Pozdnyakova in a recent client note. “The focus on avoiding the next big financial crisis may underestimate the risk in small events that can cascade.”
Last month’s effective liquidation at Leopold Aschenbrenner’s Situational Awareness, which saw around $16 billion in public stocks shifted to Citadel in a fire sale event, barely rippled markets. Nor have the titanic moves in South Korea’s Kospi Composite index, which slumped 20% and then recovered more than 25% in a matter of days last week.
On the contrary, U.S. stocks have powered impressively higher since the end of last month, with the S&P 500 notching a fresh record high, the Dow Jones Industrial Average on its way to 55,000-point market, and the tech-focused Nasdaq Composite gaining nearly 6%.
The S&P 500 has doubled since its Oct. 22 trough and sits a mere 3.9% south of an 8000-point threshold Wall Street wasn’t expecting to meet until early next year.
“Financial markets are experiencing one of their periodic pro-risk turns,” said ING’s Global Head of Markets Chris Turner. “Oil prices have been trading off all week and delivering lower market interest rates and higher equity prices around the world.”
But worries under the surface linger.
The Fed’s policy shift, championed by new Chairman Kevin Warsh, has stoked bond market volatility gauges to their highest levels since May, and triggered a notable move in longer-dated bonds that has 30-year paper trading at the highest yields since 2007.
Big Tech stocks, as well, are seeing post-earnings moves that defy both options-related forecasts and historical norms.
All six of the Magnificent Seven tech giants, in fact, have seen outsized moves tied to their June-quarter earnings reports over the past two weeks, the largest variation since the ChatGPT launch in November of 2022, according to Bank of America.
“Tech stock dispersion surged to near dot-com era extremes amidst earnings and the Situational Awareness turmoil,” said Nitin Saksena, BofA’s U.S. head of equity derivatives. “And an unconvincing Fed press conference created more questions than answers and drove long-end yields higher.”
BofA’s Global Financial Stress Index, which measures real-time market angst from 20 different inputs around the world, rose for four straight weeks into the end of July, a month that saw a meager 0.1% decline for the S&P 500, taking BofA’s index to its highest levels since April.
“While tech bubble builds can overcome such headwinds and uncertainty longer-term, shorter-term drawdowns and rotations into value aren’t unusual,” Saksena added.
Macro-related risks, many of them tied to the U.S. war in Iran, haven’t gone away, either, even as reports suggest that an interim deal to open the Strait of Hormuz could be announced this week. Brent crude oil slipped below $80 a barrel in early Wednesday trading for the first time since mid-July, but futures prices suggest levels above $75 a barrel will persist through the end of the year.
Deutsche Bank’s Templeman and Pozdnyakova point to the collapse of Silicon Valley Bank in 2023 and the deposit guarantees it triggered from regulators as an example of how ‘small vol’ events can have larger market impacts.
“The lesson isn’t that every small event becomse systemic, but the ones that do are rarely obvious in advance,” the pair said. “And when there is increased frequency of these events in a market with more leverage, less reliable havens, and policymakers tolerant of everyday volatility, ‘small vol’ events may catalyze larger problems.”
Write to Martin Baccardax at martin.baccardax@barrons.com