Stocks stage bullish comeback following $6.5T selloff

A renewed wave of dip buying spurred a rally in stocks after a roughly $6.5 trillion selloff that shook markets around the globe.

All major groups in the S&P 500 rose, with the gauge set for its biggest advance since February. After bearing the brunt of the recent meltdown, megacaps led gains on Tuesday. Following a surge in volatility to start the week, hedge funds stepped in to buy the dip in tech, according to Goldman Sachs Group Inc. Just a day later, Wall Street’s “fear gauge” — the VIX — was on track for its largest plunge in data going back to 1990.

A semblance of calm returned to global markets, following a pullback fueled by weak economic data, underwhelming tech results, stretched positioning and poor seasonal trends. Buying US shares after a slump of the scale witnessed over the past month has usually been profitable, according to Goldman Sachs. Since 1980, the US benchmark has generated a median return of 6% in the three months that followed a 5% decline from a recent high. 

“The market by any metric is ‘oversold’ and due for a bounce,” said Quincy Krosby at LPL Financial. “The lingering question now is whether the concerns that pushed the market into a cascade of selling are alleviated. Pockets of volatility are expected to continue.”

As demand for haven assets waned globally, Treasuries fell — with the rise in yields helping smooth a $58 billion auction of three-year notes in afternoon trade. Traders are also moderating expectations of deep Federal Reserve rate cuts this year. Swaps point to about 105 basis points of easing, compared to as much as 150 basis points on Monday.

“The Fed worries about systemic risk in financial markets, not disappointed investors,” said David Donabedian at CIBC Private Wealth US. “Thus, the Fed is unlikely to change its course of action due to a stock market correction. Are we headed for a near term recession, or are markets overreacting? We believe slower growth is unfolding, not a recession.”

At the close, the S&P 500 was up 1.04% while the Dow was up 0.76%. Earlier, Nvidia Corp. jumped 5% to lead gains in chipmakers. The Bloomberg “Magnificent Seven” index rose 2%. The Russell 2000 of small firms added 1.5%. Walt Disney Co. rallied on plans to raise prices of its streaming services. Caterpillar Inc. gained on a bullish forecast.

Treasury 10-year yields jumped nine basis points to 3.88%. Blue-chip firms are on track to issue more than $6 billion in bonds Tuesday, pushing yearly volume over the $1 trillion mark just eight months into the year. The Japanese yen led losses in developed world currencies after a recent surge that saw an unwind of popular carry trades. Bitcoin climbed.

The wall of worry the market built up over the past few days drove the S&P 500 to the brink of a correction, with a drawdown of almost 8.5% from the highs. 

While such sharp declines in equity prices are concerning, looking back at historic data reminds us that “dips, pullbacks and corrections of 10% or more” are a normal and healthy part of any bull market, according to George Smith at LPL Financial.

Roughly 94% of the years since 1928 have experienced a pullback of at least 5%, and 64% of years have had at least one 10% correction, he noted.

“We believe that how common these occurrences are should provide comfort to equity investors, allowing them to be patient, stay invested, and most importantly, to not panic,” Smith said.

There have been 354 such days since 1928 when the S&P 500 was down 3% or more, and the average (and median) three-month, six month and one year forward returns are all higher than long-term averages, Smith at LPL noted.

“Excesses are burned off. It doesn’t feel good, but it’s a healthy part of the process,” said Ben Kirby at Thornburg Investment Management.

Donabedian at CIBC says volatility may persist for awhile. But ultimately, he believes the secular bull market will continue. As easier monetary policy takes hold in the months ahead, it may also unleash a more balanced tone to equity returns, and the search for value beyond the Magnificent Seven, he noted.

To Lauren Goodwin at New York Life Investments, evidence against the prevailing “soft landing” view has forced the market to catch up to reality, but there’s not enough evidence to merit panic selling and an emergency acceleration of interest rate cuts.

“We would characterize the recent market pullback as a textbook correction, after months of low volatility so far in 2024,” said Carol Schleif at BMO Family Office. “The lack of volatility before the past few weeks is unusual, and our current correction is actually quite normal, especially during August, which historically is a volatile time for markets given lighter trading volumes and the summer doldrums.”

Schleif warns that while the equity market came to correction territory, it’s typically wise to let a bit of dust settle before putting new money to work as there is risk of “catching a falling knife.”

“Get used to the volatility,” said Savita Subramanian at Bank of America Corp. “The best hedge is owning high quality stocks (we use earnings and dividend stability as our key measure). Market tranches based on quality have a well-behaved relationship with the VIX - the highest quality stocks tend to outperform as the VIX rises while the lowest quality stocks tend to lag the most.”

Long-term investors don’t need to worry about short-term gyrations, said Michael Sansoterra, chief investment officer at Silvant Capital Management.

“It’s good to have these washouts on occasion,” he said. “They keep investors honest.”