Risk Events Are Everywhere! Market Volatility Significantly Intensifies

The swap market has fully priced in the Federal Reserve's interest rate hike expectations for September, implying the possibility of another hike within the year.

Written by: Bu Shuqing, Wall Street Insights

Stock investors can no longer indulge in the leisurely summer days. This week, multiple risk events, including the Federal Reserve's interest rate decision, the concentrated earnings reports from tech giants, and oil prices breaking the $100 mark, are converging, leading the market into a bumpy ride.

Microsoft and Meta will be the first to announce their earnings on Wednesday, followed by Apple and Amazon on Thursday. Meanwhile, the Federal Reserve and the Bank of England will successively announce their interest rate decisions, with European inflation data and China's PMI also set to be released. Richard Privorotsky, a partner at Goldman Sachs, pointed out that all of this is happening against the backdrop of Brent crude oil briefly surpassing $100 per barrel, global bond yields remaining high, and the stock market declining for two consecutive weeks.

In terms of market pricing, the swap market has fully absorbed the Federal Reserve's interest rate hike expectations for September, implying the possibility of another hike within the year. JPMorgan's market intelligence department warns that if the 10-year U.S. Treasury yield further breaks above 4.8%, interest rate-sensitive stocks will face greater pressure.

Volatility Heats Up, Systematic Investors' Positions Are Fragile

Geopolitical factors have already warmed up volatility in advance, and this week's earnings reports and economic data have the potential to trigger greater market fluctuations.

Historically, Goldman Sachs data shows that in U.S. midterm election years, volatility at the index level typically begins to rise in August and continues to climb until October. Richard Privorotsky believes that VIX call options are currently a good tool for tail risk hedging, and he stated that the market is more likely to maintain a volatile pattern—implied correlations remain close to the lowest levels seen in decades, and diversification is suppressing overall market volatility.

The technical aspect is also worth noting. The MSCI World Index has encountered significant resistance around 4885 points. Deutsche Bank strategists, including Parag Thatte, pointed out that systematic investors' positions are at the 70th percentile, which is considered high. Once volatility rises or the stock market breaks downwards, this position will face considerable fragility.

Additionally, last week, active investors showed significant deleveraging operations, with their risk exposure falling back to the 17th percentile near early April lows, far below the reasonable levels implied by profits and macroeconomic growth.

Valuations of the 'Seven Giants' Drop to Historical Lows, Divergence Intensifies

The earnings reports of tech giants are the focal point of the market this week. The 'Seven Giants of Technology' have been a source of funds for AI beneficiary stocks and semiconductor trades for months, but in the recent wave of profit-taking in related sectors, the Seven Giants themselves have not benefited. According to Deutsche Bank strategists, the position adjustment in large-cap tech stocks has completed about three-quarters of the process, with previous positions significantly retreating from highs.

However, there are concerning signals emerging in terms of valuations. The forward P/E ratio of the Seven Giants has dropped to the bottom of its range over the past seven years, both in absolute and relative terms. Deutsche Bank believes that this valuation compression is primarily driven by falling stock prices rather than downward revisions in earnings expectations, which may provide an opportunity for buying on dips.

Concerns about AI capital expenditures continue to fester, and Alphabet's announcement last week further reinforced this worry, suppressing investors' willingness to re-enter. However, Morgan Stanley analysts Stephen Byrd and Michelle Weaver hold a different view; they remain optimistic about the 'Intelligent Superhighway' theme and recommend holding fuel cell and energy storage companies, computing manufacturing ecosystem firms, and large-scale cloud computing companies with economies of scale and AI capital expenditure return capabilities, specifically naming Meta, Alphabet, Microsoft, and Amazon.

'Given that the recent market pullback has affected a range of AI infrastructure stocks, we believe the current moment represents a rare attractive buying opportunity,' the Morgan Stanley team wrote. 'Fundamentally, we are optimistic about the speed of AI capability enhancement, the benefits brought by AI applications, and the related capital expenditures.'

Federal Reserve Statements Become Key Variables, Bond Yields Affect Stock Market Nerves

This week, aside from tech earnings, the biggest threat to market calm comes from central bank directions. The swap market has fully priced in the Federal Reserve's September interest rate hike and implies the possibility of a second hike within the year. Any statement from Federal Reserve Chairman Kevin Warsh will be closely scrutinized by the market.

Warsh has a reserved attitude towards forward guidance, which means that interest rate hike expectations will rely more on data. If the situation in the Middle East further eases and oil prices subsequently decline, it will help the central bank achieve its policy objectives.

JPMorgan's market intelligence department emphasizes that for the stock market, the speed of interest rate changes is more critical than the absolute level. The institution pointed out that last week, the 10-year U.S. Treasury yield broke above the May high of 4.67%, with the next key observation point being the January 2025 high of 4.79%. 'If subsequent data or Federal Reserve statements support yields breaking above 4.8%, interest rate-sensitive stocks will begin to face greater pressure.'

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