Tuesday’s session unfolded under the sign of profit-taking, with all eyes focused on the upcoming decisions of the Federal Reserve. A selling atmosphere, but without panic, characterized both European and overseas markets. In Europe, only Paris it has resisted like an oasis in the desert, the only major list to close in positive territory despite several large banks being downgraded yesterday by Moody’s, following last week’s sovereign rating cut. In the United States, red dominated all major indices: S&P 500, Nasdaq 100, Russell 2000 and the veteran Dow Jones.
The S&P 500 continued to trade without solid support, marking the 12th consecutive session in which the number of falling stocks outnumbered rising ones, a sign of widespread weakness. The Dow Jones, for its part, saw its ninth consecutive session of declines, a negative sequence not seen since 1978.
The breadth of the US market highlights a worrying picture, with the twelfth session in which falling stocks outpaced rising ones. Defensive sectors, usually refuges in times of uncertainty – such as utilities, healthcare and basic goods – have suffered twelve consecutive sessions of declines, the longest streak recorded since 2012 (data available). This data not only highlights the pressure on these sectors but also the absence of a safe haven for investors in a market that seems to have lost its compass after excessive optimism.
As we highlighted in the daily newspaper of December 13th, the apparent calm of the markets hid warning signals. The VVIX/VIX ratio had then reached yearly highs of 7.15, suggesting a dissonance between low current volatility and expectations of an imminent increase. This indicator, which measures the implied volatility of the VIX, signaled latent anxiety among investors, underscoring the risk of underestimating potentially destabilizing events. Since then, the VVIX/VIX ratio has corrected, while the SKEW moves towards new highs. This adjustment indicates that although sentiment has changed, concerns about extreme scenarios have not gone away. Volatility remains on the horizon, redefining underlying fears and leaving markets exposed to possible future turbulence.
Looking at the evolution of the S&P 500 through the ETF SPYsince the beginning of the month the index has recorded an increase of 3.17%. However, the movement was driven almost exclusively by 5 key stocks: Apple, Tesla, Broadcom, Microsoft e Amazonwhich together contributed 359 basis points. In contrast, the sum of the remaining 495 companies had a negative impact, subtracting 42 basis points. Nvidia was the main cause of this slowdown: the decline in the stock, currently in correction according to market definitions, weighed 58 basis points on the overall balance of the index. This scenario highlights a significant dependence of the index on a small group of technology stocks, underlining the fragility of the market when it relies on a few stars, while the rest of the stock firmament struggles to shine.
Dependence or, better yet, concentration, on some securities which returns to the center of attention for the Nasdaq 100. Regulation, in fact, requires a rebalancing if all the companies representing more than 4.5% of the benchmark add up to 48% combined, or more. Just a year after being downsized in the Nasdaq 100 because they got too big, the world’s biggest tech companies may face another pruning when the benchmark index rebalances this week. Regulations designed to limit the influence of larger members in the gauge have come under pressure after companies such as Apple and Microsoft grew to unprecedented size. Nasdaq has already been forced to address the issue in July 2023, reducing the weightings of seven companies to bring them back into compliance. However, their growth continued to be so significant in the following months that the indicator is again too unbalanced, which may require another selection. As of Monday’s close, eight members, including Nvidia, Amazon, Meta Platforms, Tesla Broadcom and Alphabet, each represented more than 4.5% of the Nasdaq 100, with total representation close to 52%. Nasdaq’s methodology document suggests the combined weighting could be reduced to 40%. A review would mean that index funds like Invesco QQQ Trusts must change holdings. This adds an extra wrinkle to an event where MicroStrategy, Palantir Technologies e Axon Enterprise will join the Nasdaq measure, replacing Illumina, Super Micro Computer e Modern. The reorganization of the largest constituents is a consequence of the unstoppable rally fueled mainly by optimism about artificial intelligence, with the group advanced 79% on average year to date, about four times larger than the average stock in the rest of the Nasdaq 100.
All eyes on the FOMC today. Today’s meeting comes at a crucial time, with markets already ready to price in a 25 basis point rate cut, the third step in this monetary easing cycle. A move that would bring the range of reference rates to 4.25% – 4.5%. But the rate decision is not the only factor at play. Attention will also be paid to the updated projections and the FOMC’s view on the terminal rate. Chairman Powell will have to balance the message with a probably neutral tone, aware of market expectations. However, his words could suggest a slowdown in the pace of cuts, a signal that markets will read with extreme caution.
Meanwhile, bond markets are already anticipating an overall rate cut of 75 basis points over the next 12 months, reflecting the belief that the Fed is set to return to a more accommodative monetary policy. In a context like this, Powell’s every word and every updated data become essential, pieces that build the mosaic of monetary policy, where market sentiment and the science of numbers intertwine to outline the Fed’s next steps.
