Dow Drops 1,000 Points: Emergency Rate Cut Looming?
As the new week unfolds, a wave of global sell-offs has returned to the United States after sweeping through the Eurasian continent. At the time of writing, Europe's three major stock indices have collectively plummeted over 2.5%, reaching a six-month low. The Dow Jones Industrial Average dropped more than 1000 points in early trades, while the Nasdaq saw a decline exceeding 6%. The "Seven Giants" of tech saw their combined market value evaporate by a staggering $1.3 trillion. Meanwhile, the Chicago Board Options Exchange's Volatility Index (VIX) surged over 130% to 55 points, marking its highest level since 2020. The yen and Swiss franc, often seen as safe-haven currencies, soared as crowded arbitrage trades collapsed. Investors speculate that some market players are offloading profitable assets, while liquidity concerns have also caused fluctuations in the precious metals markets.
The tech sector, already racked with volatility, continues to face immense pressure. Last week, disappointing earnings reports from major companies like Intel, Amazon, Arm, along with subpar performances from Microsoft and Nvidia, have intensified market fears. These developments have cemented the tech sector's position as the worst-performing industry since the second half of the year began, with the Philadelphia Semiconductor Index plummeting 23% in just one month, reaching its lowest point in four months.
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Further bad news has perpetuated the downward spiral this week. On Monday, Bank of America announced it had downgraded Microchip Technology's rating from “Buy” to “Neutral,” reducing the target price from $110 to $90. These pieces of negative news have weighed heavily on investor sentiment.
Nvidia, which officially entered bear market territory last week, is also facing a significant setback as its stock price fell over 14% in early trading. According to U.S. media reports, a design flaw may delay the mass production of Nvidia's upcoming AI chip, Blackwell, by three months or longer. This setback could adversely affect major clients like Meta and Alphabet's Google, who have together ordered chips valued at tens of billions of dollars. Nvidia launched the Blackwell chip series in March of this year to replace its flagship AI chip, Grace Hopper, designed to accelerate the development of AI applications. Insiders reported that Nvidia notified Microsoft and another major cloud service provider last week about the production delay of the Blackwell series smart chips.
Meanwhile, the investment community is also rattled by Warren Buffett's significant reduction in his stake in Apple. This has sparked investor anxiety, causing Apple's stock to nosedive nearly 10% in early trading. Just two years ago, Buffett regarded Apple as one of his conglomerate's top four priorities, alongside Berkshire's insurance, utilities, and BNSF Railway businesses. This led investors to believe that he would hold onto Apple shares indefinitely, akin tohow he invested in Coca-Cola and American Express decades ago. Buffett has been vocally supportive of Apple CEO Tim Cook, who attended Berkshire's annual meeting in Omaha in May. After a first-quarter divestment of 116 million shares, the size of the recent sale almost quadrupled.
Dan Ives, a tech analyst at Wedbush, conveyed in a report that Buffett remains a firm believer in Apple, dismissing the sell-off as merely noise rather than a signal of impending doom. Despite these challenges, Apple remains the largest position in Berkshire’s portfolio, more than double that of Bank of America.
CFRA Research analyst Cathy Seifert expressed a preference for interpreting Apple’s sale as a form of prudent portfolio management, given the tech giant's substantial stake within Berkshire. However, she speculated that Buffett might also be bracing for an economic downturn, reflecting preparation for a weakening economic environment.
As for the Federal Reserve, thoughts are brewing on whether a preemptive interest rate cut could be on the horizon. On Monday, the Chicago Fed’s Austan Goolsbee stated in a media interview, “The Fed's job is straightforward: to maximize employment, stabilize prices, and maintain financial stability. That's what we are aiming to do.”
Goolsbee noted that the Federal Reserve's operations are forward-looking. Should the overall economic conditions shift or if any specific sector deteriorates, the Fed would step in to “fix it.” When asked whether the softening labor market and manufacturing sectors would prompt any action from the Fed, Goolsbee did not promise specific measures but hinted that maintaining a "restrictive" policy stance would be pointless if the economy is weak.
As the U.S. July non-farm payroll report was released, a closely watched recession indicator—the Sam Rule—triggered alarm bells within the market. Former Fed Vice Chair Alan Blinder recently published an article entitled “This Time the Fed Should Cut Rates,” which argued that current conditions are tight. He pointed out that inflation rates are lingering between 2.5% to 3%, and with the federal funds rate between 5.25% to 5.5%, the real rates (adjusted for inflation) hover around 2.5% to 3%. “Since last September, the 12-month Personal Consumption Expenditures (PCE) Price Index has either stabilized or declined monthly. To me, this suggests a downward trend,” he wrote.
In a press conference last week, Fed Chair Jerome Powell reflected on possible rate cuts in September and discussed considerations regarding policy stance, noting, “The question is whether all the data, the changing outlook, and risk balance align with the confidence in rising inflation and maintaining a stable labor market.”
Amid the turbulence in the job market, data from MSCI revealed that commercial mortgage delinquencies and foreclosures across the United States hit $20.5 billion in the second quarter. This figure represents the highest level since 2015, marking a 13% increase from the first quarter. It's clear that the commercial real estate sector is under intense scrutiny, with firms like Blackstone Group facing heightened scrutiny from investors. Concurrently, the ISM Manufacturing Index fell significantly from June’s 48.5 to 46.8 for July, with 11 out of 16 surveyed industries contracting in that month. These two sectors alone account for a quarter of the U.S. economy.
Amidst looming recession fears, federal funds futures indicate there is now a 100% probability of a rate cut in September. However, given the sharp decline in Treasury yields, the Fed is urged to immediately lower key interest rates by 50 basis points to align more closely with these yields. Historically, the last emergency rate cut by the Fed took place in March 2020 amidst multiple mid-day trading halts in the market; however, the current situation has yet to escalate to that level.
Interestingly, Goldman Sachs noted that hedge funds globally continued to ramp up their short positions in stocks within their portfolios during the week ending August 1. The sectors targeted by these positions included financials, industrials, real estate, and energy. At the same time, defensive healthcare stocks were also being offloaded at one of the fastest paces seen in a year. Nevertheless, the firm remains optimistic, estimating a mere 25% chance of a recession in the U.S., suggesting that the Fed retains the capacity to restore market optimism.