Is this the end of the bull market?

The
seeds of what would become a tumultuous Monday for Asian markets were sown
during the previous Friday’s U.S. trading session. A seismic shift in investor
sentiment was triggered by a far weaker-than-expected Nonfarm Payrolls (NFP)
report, which painted a less rosy picture of the U.S. economy than anticipated.
This unexpected economic data sent shockwaves through financial markets,
causing U.S. stocks to plummet and bond prices to surge. As a result,
volatility spiked dramatically, and market participants began pricing in the
possibility of more aggressive interest rate cuts from the Federal Reserve
(Fed) this year. This perfect storm of negative factors set the stage for a
global market meltdown.

As
already said, the catalyst for the ensuing market turmoil was the unexpectedly
weak NFP report released by the U.S. government. The data, which revealed a
mere 114,000 jobs added in July—a stark contrast to the downwardly revised
179,000 for June and market expectations of 175,000—shocked the investors. This
significant miss triggered widespread concerns about a potential recession as
the unemployment rate climbed to a near three-year high of 4.3%, marking its
fourth consecutive monthly increase. Investors reacted swiftly and decisively,
dumping stocks in a classic risk-off maneuver. The S&P 500 plummeted at the
open, reflecting the bearish sentiment. Simultaneously, bond prices surged,
driving the yield on the benchmark 10-year Treasury note to its lowest level
since December. The dollar index weakened considerably as markets dramatically
increased their bets on a substantial 50-basis point (bps) interest rate cut by
the Fed in September, a sharp reversal from the previous expectation of a 31%
probability.

The
market panic that began in the U.S. quickly spread to Asia, with Japan bearing
the brunt of the sell-off. The Nikkei 225, Japan’s benchmark stock index,
suffered its most catastrophic decline since the infamous Black Monday of 1987,
plunging by a staggering 12% within just six hours. While the looming threat of
a U.S. recession undoubtedly fueled the sell-off, the situation was further
aggravated by escalating geopolitical tensions in the Middle East and the rapid
unwinding of the yen carry trade.

“The Bank of Japan (BoJ) had long been the
cornerstone of the carry trade strategy, providing investors with an abundance
of cheap yen to fund investments in higher-yielding assets”, says Kar Yong Ang, Octa analyst, adding that
after BoJ decided to raise its key interest rate and signaled a potential
tapering of its stimulus program, the decline in USDJPY accelerated. Indeed,
the Japanese yen surged in value by over 10% in less than a month, triggering stop orders and forcing numerous
macro hedge funds to liquidate their long USDJPY positions. Thus, the unwinding
of the yen carry trade triggered a vicious cycle of selling pressure, which
spread into other markets.

Mirroring
the broader market meltdown, the cryptocurrency market experienced a dramatic
flash crash, with the price of Bitcoin plummeting sharply. The primary catalyst
for this steep decline was the same as that for traditional equities:
widespread investor fear of a potential U.S. recession ignited by the
unexpectedly weak NFP report. The report’s dismal employment figures heightened
concerns about economic growth, prompting a risk-off sentiment that cascaded
across all asset classes, including cryptocurrencies.

However,
the market began to show signs of a cautious recovery after a turbulent Monday,
during which over $1 billion in leveraged cryptocurrency positions were
liquidated and major tokens plummeted by as much as 20% in value. Despite the
slight price recovery, the Bitcoin futures funding rate has remained negative
over the past 24 hours. This indicates high demand for short positions, with
traders still betting on a decline in Bitcoin’s price. Consequently, this
situation could potentially lead to a short squeeze. A short squeeze occurs
when the price of a heavily shorted asset unexpectedly rises, forcing short
sellers to buy back the asset to cover their positions. This buying activity
can create a rapid increase in the asset’s price, further accelerating the
upward movement as more short sellers are compelled to close their positions.

By
Monday evening, the situation had started to normalize. Already on Tuesday,
S&P 500, Nikkei 225 and bitcoin reversed to the upside and a sense of
normalcy returned to the markets. Fed officials’ comments helped to soothe the
investors with Austan Goolsbee, Chicago Fed President, saying that while the
U.S. employment data on Friday was weaker than expected, the U.S. was not in a
recession. Still, investors continue to bet on aggressive rate cuts by the Fed,
which are by no means guaranteed. Although buying the dip has proved to be a
very profitable trading strategy over the past decade, it may not end well this
time. U.S. ISM Services PMI actually recovered from a four-year low in July,
Monday’s data showed, which may help quash fears of a recession and make
investors reconsider their excessively dovish interest rate expectations. What
is clear is that traders should prepare for an extended period of uncertainty
and volatility. However, it remains to be seen whether the latest events
represent the end of the bull market in stocks.

“In case the Fed starts to indicate that it is not planning to deliver
a 50-bps cut in September, investors’ sentiment may turn bearish again. With no
major economic data releases scheduled until the U.S. CPI report on August 14,
technical trading may prevail”, says Kar Yong Ang.