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Economic Observer reporter Cai Yuekun and Hong Xiaotang Will this sudden and epic "emotional storm" continue to wreak havoc? Will the aftermath of the huge shock in the international financial market subside?

At least when the U.S. Department of Labor released data on "initial unemployment claims during the week" on the evening of August 8, showing that the U.S. job market had warmed up, U.S. stocks surged; and after the Bank of Japan took action to calm global market sentiment on Wednesday (August 7), the yen, one of the "culprits", plunged nearly 300 points, and Asian stocks rose.

The current Wall Street "fear index" VIX (Volatility Index) also tells people that the market, which has undergone a textbook adjustment, has calmed down for the time being after several days of "roller coaster" mode. Although the storm warnings that had gathered before may not have been truly lifted.

The international financial market remains so sensitive that any disturbance will cause it to react with shock.

Arindam Sandilya, co-head of global foreign exchange strategy, said that when the yen appreciated sharply by 11% in the past month, investors who rely on low-cost currencies to finance high-yielding assets were caught off guard. Speculators' yen carry trades have been unwound by about 50% to 60%.

This sensitive and fragile, yet resilient market has also made analysts somewhat indecisive: one moment they say the "epicenter" of the global stock market crash is the Japanese yen - due to the Bank of Japan's interest rate hike, which has led to a major reversal of carry trades; the next moment they point the "epicenter" to the U.S. market, namely concerns about a U.S. economic recession, especially after disappointing job market data; or a combination of both, coupled with the escalation of conflict in the Middle East and concerns about a tech bubble and other negative effects, which have led to major turmoil.

People don’t know how an epic global market turmoil will start and end. The real aftermath of the market shock may be the “invisible elephant”. Market players need to learn how to get rid of emotional shackles and predict the future with long-term thinking.

Big earthquake

Although it is impossible to estimate the relative weight of quantitative funds and the size of yen carry transactions, there are clues - let's review how "Black Friday" (August 2) and "Black Monday" (August 5) were influenced by emotions.

No one expected that the Bank of Japan's "final turn" and the Fed's "final hesitation" would have such a huge impact. Coupled with recession concerns, escalating conflicts in the Middle East, and pessimistic expectations of the tech bubble, the combination of various factors has dealt a strong blow to the global financial market.

After experiencing "Black Friday" in the global market, a new week of "Black Monday" has arrived.

The VIX index of fear continues to hit new highs. On August 2, the VIX was 23.39, a sharp increase of 25.82% from 18.59 on the previous trading day and a 46.92% increase from 15.92 in the same period last year. During the trading session on August 5, the VIX once soared to 56.92, an increase of 143.35%, and closed at 38.57 (+64.90%). This shows that the market is strongly concerned about future uncertainty and volatility.

Global stock markets "collapsed", several "circuit breakers"... this scene is not unfamiliar, and it is quite similar to the "stock market crash" in March 2022, or the crisis moment in October 2008.

On August 5, global stock markets suffered a huge shock, and investors exclaimed: "We witnessed history again!"

On that day, the Nikkei 225 Index triggered the circuit breaker mechanism twice and finally closed at 31458.42 points, a drop of 12.40%. This drop has wiped out all the gains created by the Nikkei Index this year, and this is also the largest drop in the history of the Nikkei Index, surpassing the record of Black Monday in October 1987.

In addition, the Korean stock market's KOSPI fell 8.77% throughout the day, and the Kosdaq index fell more than 11%. Posco (005490.KS) and LG Chem (051910.KS) fell nearly 12%, and Kia Motors (002270.KS) fell more than 10%.

In the Taiwan stock market, the Taiwan Stock Exchange Weighted Stock Price Index closed down 8.4%, the largest single-day drop in history, closing at 19,830.88 points, falling to the lowest closing level since April 23.TSMC(2330.TW) closed down 9.8%, its biggest drop ever.

U.S. stock index futures also fell collectively. Nasdaq 100 index futures fell more than 5%, and S&P 500 index futures fell nearly 3%. At the same time, U.S. technology stocks fell across the board in night trading.NvidiaBroadcomThe stock price plummeted by more than 14%, and AMD fell by more than 12%.Micron TechnologyDown more than 10%,MicrosoftDown more than 8%.

In the European stock markets, the major stock indices of countries such as the United Kingdom, Germany, France, Italy and Spain all suffered heavy losses.

Disturbed by multiple factors such as overseas markets, the three major A-share indices were slightly restrained, but also closed down collectively, with a drop of more than 1%. Among them, the ChiNext Index fell the most, falling 1.89% on the day. More than 4,700 stocks in the two markets fell.

This reminds people of "Black Monday" on October 19, 1987, and some people vaguely smell the precursor of the "financial crisis".

The "Seven Big Tech Companies" in the U.S. stock market all plummeted. On August 4, local time, Musk responded to an online article about "Warren Buffett cuts his stock position (including his major holdings)"apple, reduced its holdings by 50% and increased its reserves of cash equivalents and short-term Treasuries" in a post saying: The Fed needs to lower interest rates. It is stupid that they have not done so yet.

The CME FedWatch tool shows that the probability of the Federal Reserve cutting interest rates by 25 basis points in September is 93.3%.

However, on August 6, the Nikkei 225 Index rebounded strongly, closing at 34,675.46 points, up 10.23%. The MSCI China A50 Connect and the Hang Seng Index Connect also rebounded.

On August 7, global markets were in turmoil again. U.S. stocks fell sharply due to the poor performance of a $4.2 billion Treasury auction, highlighting the fragility of the market. Investors' concerns about future interest rate increases and slowing economic growth intensified, leading to a collective decline in the three major U.S. stock indexes.

On August 8, market sentiment recovered somewhat. The Dow Jones Industrial Average rose sharply by 1.76%, the Nasdaq rose by more than 2.87%, and the S&P 500 also rose by 2.3%. However, European stock markets rose and fell, with the UK FTSE, Germany DAX, and France CAC closing at 8144.97 (-0.27%), 17680.40 (+0.37%), and 7247.45 (-0.26%) respectively.

On August 9, most of the major Asia-Pacific stock indices closed higher. The South Korean Composite Index rose 1.24% to close at 2588.43 points, with a cumulative decline of 3.28% from August 5 to 9, and a drop of 9.40% in the past 20 trading days. The Nikkei 225 Index rose 0.56% to close at 35025 points, with a cumulative decline of 2.46% from August 5 to 9, and a drop of 17.05% in the past 20 trading days.

In addition, as of the close of August 9, the Shanghai Composite Index rose slightly by 0.27% to close at 2862.19 points; the Shenzhen Component Index fell by 0.62%, and the ChiNext Index fell by 0.98%. However, in terms of trading volume, A-shares traded 566.05 billion yuan throughout the day, a new low since October 11, 2022.

trend

On the evening of August 8, the data released by the U.S. Department of Labor showed that the U.S. job market has rebounded. The number of first-time unemployment claims in the U.S. in the week of August 3 was 233,000, lower than the expected 240,000 and lower than the previous value of 249,000.

The data showed that the number of people applying for unemployment benefits for the first time has decreased, which eased the market's concerns that the US labor market may cool down too quickly. Analysts pointed out that the improvement in this data will help stabilize market sentiment, especially in the recent situation of large fluctuations in US stocks. This is undoubtedly an important good news. Affected by this, the three major US stock indexes opened higher on Thursday, with the Dow Jones Industrial Average up 1.76%, the Nasdaq Composite Index up more than 2.87%, and the S&P 500 up 2.3%.

On Wednesday (August 7), Bank of Japan Deputy Governor Shinichi Uchida said the Bank of Japan will not raise interest rates amid current market instability, reducing the likelihood of a near-term rise in borrowing costs. In a speech to Japanese business leaders, Uchida stressed that it is necessary to maintain the current loose monetary policy due to the volatility of domestic and foreign financial markets.

Luke Bartholomew, deputy chief economist at Aberdeen, said that in early August, the market fluctuated sharply, the stock market suffered a sell-off, the yen appreciated significantly, and US interest rate expectations fell sharply. Recently, the market has begun to stabilize. He believes that these trends have exaggerated the changes in the global economic outlook.

In short, it is "overshooting". Luke Bartholomew's logic is that weak US data has rekindled fears of a recession. US labor market reports have weakened across the board, and the unemployment rate is now rising in a manner consistent with historical recessions.

However, the Institute for Supply Management (ISM) overall composite index rebounded to 51.4 in July from 48.8 previously, and the Purchasing Managers' Index (PMI) was even stronger at 55. Meanwhile, although the credit market, which has tightened sharply over the past few years, has not shown any easing, the survey of senior credit officers shows that credit conditions are stabilizing.

In fact, Luke Bartholomew believes that the National Bureau of Economic Research (NBER) recession indicator barely shows any signs of a recession. Overall, "while we should be very cautious about the deterioration of the U.S. labor market, we do not think the economy is heading for a recession."

The second, related driver is the perception that the Fed may be lagging in its response to weak US data. If the Fed had met in mid-August instead of a week ago, it would have likely cut rates. But that doesn't mean an unscheduled meeting is likely to cut rates now. In fact, such a move could spook markets and increase volatility.

The third driver of volatility, in Luke Bartholomew's view, is the unwinding of yen carry trades. Given that Japan's underlying inflation problem is far from reaching the target, the need for Japan to significantly tighten financial conditions is not obvious.

It is worth mentioning that the US stock market fell sharply on Wednesday (August 7) ​​due to the poor results of a $4.2 billion Treasury auction, further highlighting the fragility of the market. Following the sharp drop on Monday (August 5), the stock market has returned to a similar low. Mark Hackett of Nationwide pointed out that recent market events have demonstrated the dominant role played by emotions in market fluctuations, especially against the backdrop of generally optimistic market sentiment and positions. He said that "the stock market is still fragile" and analysts believe that only more signs that the market has bottomed out can re-inspire the confidence of bulls.

This also shows that the current market sentiment is still unstable, investors lack confidence in bargain hunting, and are uncertain about future trends. It further shows that the market is still in a highly sensitive state, and emotional fluctuations may continue to dominate short-term market trends. At the same time, once there is good news, market sentiment will immediately heat up, just as the US stock market rose sharply on August 8.

Perhaps "sensitive + fragile + resilient" is an appropriate way to describe the characteristics of the current market. For example, the current market is extremely sensitive to various news, especially news related to macroeconomic data, central bank policies and geopolitics. Just like on August 8, US stocks rose strongly after being stimulated by good news. This sensitivity reflects that investors' emotions fluctuate greatly, and they tend to react quickly to new information, whether positive or negative.

Although the market is able to respond positively to positive news, the overall environment remains very fragile. For example, any negative economic data, policy changes or escalation of geopolitical tensions could quickly trigger sharp market fluctuations.

At the same time, despite its sensitivity and fragility, the market still shows a certain resilience - for example, it has experienced several declines recently, but once good news emerges, the market will rebound quickly.

Therefore, the current market can perhaps be described as a delicate balance between sensitivity, fragility and resilience. This state means that market participants must be more flexible in the face of uncertainty and adjust their strategies in a timely manner to cope with possible rapid changes.

One reality that cannot be underestimated is that quantitative funds, which are facing major challenges chasing Wall Street's hottest trades, may increase market volatility.

These funds usually rely on trend-following strategies, which means increasing corresponding investments when the market continues to move in a certain direction. For example, according to foreign media reports, in the first half of this year, many quantitative funds made large bets on the following trends: first, increasing holdings of stocks - the funds expect the stock market to continue to rise; second, shorting government bonds in developed countries - the funds believe that bond prices will continue to fall (yields will rise); third, predicting that the yen will continue to depreciate - the funds expect the yen to weaken further against other currencies.

However, in July, the market trend suddenly reversed, causing the strategies of these quantitative funds to "collectively fail". The stock market fluctuated, and government bond yields unexpectedly fell (the yen strengthened), all of which caused huge losses in the original bets. This situation shows that the complexity and volatility of the market are increasing, and investment strategies that rely on historical trends and model predictions may be exposed to greater risks when facing sudden market reversals.

For quantitative funds that rely on trends, it may be necessary to re-evaluate the parameters and assumptions of the model, especially if market volatility increases.

The other side of the coin is that funds and institutions that chase Wall Street's hottest trades, especially quantitative funds, also play an important role in market volatility. The operations of these funds may exacerbate volatility when market conditions change suddenly, and further affect market stability by amplifying market sentiment and exacerbating liquidity risks. Therefore, although these funds may contribute liquidity when stabilizing the market, they may also become amplifiers of market volatility in extreme market environments.

These funds usually rely on algorithms and models to conduct large-scale automated trading based on market trends. When market trends suddenly reverse, such as a stock market decline or a sudden change in interest rates, these funds quickly adjust their positions, which may trigger large-scale buying or selling. This rapid and concentrated trading behavior often exacerbates short-term market volatility. For example, when many quantitative funds close their positions at the same time, the market may experience violent price fluctuations or even a "stampede" effect.

Response and Trends

After experiencing such a "roller coaster" market trend, what is the future of the market? How can investors defend against the "invisible elephant"?

UBSThe Fed said that weak U.S. economic data has unsettled investors and that they are concerned that the Federal Reserve may have to wait a long time before cutting interest rates, and that the U.S. economy is at risk of recession. These concerns are premature. The U.S. economy is heading for a soft landing, not a contraction. The Fed will cut interest rates by 100 basis points this year, most likely starting with a 50 basis point cut in September, so that the U.S. economy can avoid a recession and still achieve growth close to 2%.

UBS said that in the scenario where the dollar-yen exchange rate remains at or above 150, we could see Japanese stocks rebound in the short term. In the alternative scenario where the dollar-yen exchange rate remains well below 150, UBS believes that Japanese stocks may take longer to regain investor confidence.

UBS recommends that Japanese investors consider the following strategies: Pursue quality growth and focus on investing in companies with strong competitive advantages and good sustained growth. Seize opportunities in artificial intelligence. Diversify investments using alternative assets. Long-term investors can consider investing in hedge funds and private equity as a way to find new sources of returns and minimize volatility in portfolio value.

Luke Bartholomew said that they still expect the Fed to cut interest rates by 25 basis points in September and clearly pointed out that it will continue to take a further easing policy path this year and next year. However, if there is another weak labor market report or market pressure fails to ease, the Fed may accelerate the pace of rate cuts. In addition, he also mentioned that the Bank of England and the European Central Bank are expected to extend their rate cut cycle later this year, but he believes that the market's recent pricing may overestimate the speed and magnitude of rate cuts.

Based on the aforementioned statement that "Japan's need to significantly tighten financial conditions is not obvious", Luke Bartholomew believes that although there may be further liquidation of carry trades, the Bank of Japan is expected to further tighten its policy, but policy rhetoric may now soften and the next rate hike may be delayed until later this year.

When global stock markets fluctuate, where will A-shares go?

An investment research person from a large public fund institution in Beijing believes that against the backdrop of increased volatility in external markets, the probability of global funds flowing back to Chinese assets will increase.

The source said that considering that external risks have not been completely cleared, the A-share market is expected to continue to fluctuate at the bottom in the short term. However, external risks do not constitute the main contradiction for the time being, and the signal of domestic policies to stabilize growth has been strengthened. The bottom support of the market is still solid, and the probability of market stabilization has further increased. The allocation strategy of A-shares is also expected to usher in a turning point. From the previous external dominance, it has gradually returned to the relevant investment opportunities brought about by the domestic policy efforts.

GF SecuritiesIt is believed that in the future, the return on overseas assets will decline, the volatility and systemic risks will increase, and the attractiveness of RMB assets will be further enhanced, which will be conducive to the return of cross-border capital and the appreciation of the RMB. From historical experience, the appreciation of the RMB will have a significant positive feedback effect on the core assets of A-shares. The plunge in the external stock market has disturbed the short-term trading sentiment of A-shares, but the implementation of domestic policies in the medium term is still worth looking forward to, and the strengthening of the exchange rate will further open up the space for monetary policy. At present, important domestic institutional investors continue to support A-shares through ETFs (Exchange Traded Open-End Index Funds), and it is expected that the index will have limited downward space.

At this point, it may not be an exaggeration to describe the violent turmoil in the global market as an "epic emotional storm", although it is extremely difficult, and even impossible to predict the start and end of the violent turmoil in the global market. Market turmoil is usually caused by a combination of factors, which may include a sudden deterioration in economic data, major geopolitical events, policy changes, and financial system risk exposure, including liquidity risk. The start and end of turmoil are often the result of the interweaving of multiple complex variables.

Obviously, these explicit or implicit variables are still there, multiple risk factors still exist, and it is difficult to say that the over-corrected market has truly stabilized.

The "invisible elephants" refer to those potential, unpredictable but huge risk factors. Although investors cannot fully predict the arrival of these risks, they can take measures such as "diversifying investments", "maintaining liquidity", "hedging risks" and "long-term perspective", such as focusing on long-term investment goals, avoiding emotional decisions during short-term market fluctuations, and "paying attention to macroeconomic and geopolitical dynamics" to better defend against those "invisible elephants" and maintain resilience and coping capabilities in market turmoil.