Key points:

  • The main trigger for the decline was the forced exit from trades using popular yen carry trades.
  • Despite some calming down, markets remain relatively volatile, and this situation may persist for several months.
  • The upcoming US elections and geopolitical tensions also create additional uncertainty in the markets.

After a recent period of heightened volatility, with stock prices swinging wildly, the US stock market is showing signs of calming down. However, based on historical data, we can expect markets to remain relatively volatile for the next few months.

The Cboe Volatility Index (.VIX), considered one of the most reliable indicators of investor anxiety on Wall Street, has shown a significant decline after hitting a four-year high last week. Accordingly, stocks that had previously been the subject of the heaviest selling have begun to recover their positions.

Why did the market fall?

Investors are interpreting the rapid fading of the recent market panic as evidence that the collapse was driven primarily by a massive liquidation of leveraged positions, including the popular yen carry trade, rather than by fundamental problems in the global economy. In other words, the sharp decline was driven by technical factors rather than by long-term concerns about the outlook for global growth.

However, despite the quick return to calm, historical data suggests that periods of heightened volatility, accompanied by sharp increases in the VIX volatility index, are often protracted. On average, it takes about 170 trading sessions for the index to return to its long-term average after it rises above 35, a level traditionally associated with high levels of investor anxiety. Thus, even after the recent decline, markets may remain relatively jittery for several months, which could limit the risk appetite that was so characteristic of the first half of the year.

It is worth noting that the current turmoil in the US stock market has occurred against the backdrop of a long period of sustained growth, during which the S&P 500 index demonstrated impressive dynamics. However, disappointing earnings reports from several tech companies published last month triggered a massive sell-off in stocks and led to a sharp increase in volatility.

Traders are advised to remain cautious

In late July and early August, markets experienced a much deeper correction. The Bank of Japan’s surprise decision to raise interest rates by 25 basis points triggered a mass liquidation of positions opened in the yen carry trade. Traders who had used cheap yen to finance speculative trades in assets ranging from American tech companies to cryptocurrencies were forced to quickly close their positions.

At the same time, investors were increasingly studying macroeconomic data, fearing a slowdown in the American economy. The S&P 500 index has lost 8.5% of its value compared to July, just short of the 10% correction level. Despite this, the index still shows positive dynamics for the year, having increased by 12%.

Investors’ concerns about the further development of the situation are well-founded. The market is awaiting the publication of important macroeconomic data, including the consumer price report, which should provide a clearer picture of the state of the US economy. Investors are trying to assess whether the current slowdown is temporary or could develop into a more serious recession.

In addition to economic factors, investor sentiment is also affected by a high degree of political uncertainty. The tense pre-election situation in the US, as well as growing tensions in the Middle East, are increasing investor concerns.

In the current situation, experts recommend investors to remain cautious and avoid hasty decisions. Until the VIX volatility index falls below its long-term average of 19.5 points and consolidates at this level, it is premature to talk about market stabilization. In conditions of high uncertainty, attempts to determine the bottom of the market or individual stocks are associated with increased risks.