US markets paused their slide this week as the tech sector found its footing following an AI sell-off sparked by high borrowing costs and doubts over data centre returns.
A bevy of upcoming catalysts will put this fragile pause to the test.
There could be a smooth transition where growing profits quietly push stock prices slowly higher over time, but there is also a real danger that the market suddenly snaps and suffers a major drop.
Last Friday, the S&P500 fell 1.1 per cent as a final wave of AI selling hit the tape. Such a move is not overly concerning, but what has traders worried was the intraday move in the Cboe Volatility Index, which went from under 16 to over 22 in two hours, a sign of significant investor fear and demand for options hedges.
Since 1990, only nine days have had a larger jump in the VIX on a smaller drop in the S&P500 than last Friday, according to SpotGamma.
Then there are the thin markets we have seen since the end of the quarter. On October 12, the State Street SPDR S&P 500 ETF Trust saw its lowest full trading day volume since 2003. Reduced liquidity can be a harbinger of big gaps lower in prices.
The nervous, low-liquidity market is now preparing to run the most challenging gauntlet of risks we have observed all year, beginning this Friday.
Fiscal issues
This Friday, France faces a potential credit downgrade as Moody’s reviews its Aa3 long-term sovereign bond rating, which currently carries a negative outlook.
Add in continuing riots that threaten France’s retail and tourism industries and an upcoming presidential election in which far-left candidate Jean-Luc Mélenchon has proposed cancelling part of the national debt and France’s fiscal situation looks untenable. Worse, the EU could face an existential crisis from the fallout.
An ECB bailout is likely inevitable, but unlikely to come before things get much worse. Watch for changes in “le spread”, the difference between German and French 10-year yields, currently 159 basis points.
On October 28, the UK Autumn Budget takes place. With UK borrowing costs at 30-year highs chancellor John Healey faces the challenge of matching public spending and tax revenue without smothering economic growth.
AI trade catalysts
As early as Friday, the official filing of Anthropic’s S-1 and the ensuing roadshow could provide a deeper look into the company’s financial performance and spending plans.
How much capital Anthropic plans to raise in its IPO will be the key for markets. Targeting a smaller raise could protect a higher valuation, but might trigger scepticism over how the AI firm will fund its massive infrastructure needs in a volatile bond market.
Conversely, a larger capital injection secures the necessary balance sheet for heavy cap-ex at the expense of a lower valuation.
The one-week period between October 28 and November 3 will see about half of the S&P500 index by market capitalisation report earnings, including tech heavyweights Alphabet, Microsoft, Amazon, Apple and AMD.
Will capital expenditures continue to grow and is it doing so at the expense of free cash flow? Are there signs companies are monetising AI?
Military escalation into the midterms
As early as this weekend, Iran may launch a pre-emptive attack aimed at raising energy prices in a bid to influence US midterm elections.
It has already stepped up attacks on commercial shipping in recent weeks and escalation could see strikes on Persian Gulf shipping ports, refineries, pipelines or undersea internet cables.
The US has been bolstering its naval forces in the region despite Donald Trump’s pledge not to attack before the midterms on November 3.
Fed meeting
With influential FOMC members Fed vice-chairman Philip Jefferson and New York Fed president John Williams taking a wait-and-see approach, odds of a hike are low on October 28.
Markets could struggle to understand the need for a pause given September’s hotter-than-expected inflation report.
Back in July, it was suggested the Fed shouldn’t wait for September to raise rates, that upside inflation risks due to spiralling geopolitics were too great to ignore.
We are caught in a similar situation now.
Keep an eye on the number of dissenting votes, higher disagreement directly erodes the market’s confidence in the Fed’s decision.
A combination of any of these catalysts could be a most toxic brew for markets as financial risks act as multipliers rather than additions when sentiment turns.
CNBC