Welcome to Wall Street’s summer from hell: a period of extreme
volatility
and uncertainty that will bring a near-biblical reckoning to markets. The last will become first, and the first will become last.
After years of inflating, it’s becoming clear that the “everything bubble” has burst. Since the start of 2022, the S&P 500 has fallen by more than 18%, and the tech-heavy Nasdaq is down almost 30%. A punishing combination of still hot inflation, hiked interest rates, war in Europe, lockdowns in China, unprofitable companies facing reality, and
recession
fears is making it clear that this isn’t just a short-term drawdown — it’s a pivotal shift for markets.
“I think that no one really has a clue, that’s my take,” one seasoned investor told me.
“If the equity markets sell 30% from here, I would be buying most likely then,” he continued, before changing his mind and correcting himself.
This kind of confusion and trepidation is gripping Wall Street ever tighter as the weather heats up. The seasoned investor, who spoke on the condition of anonymity to freely discuss his strategy, told me that there are too many variables affecting the market — from Putin’s mood to the price of potash — to consider when trying to position for the future. Too many things that could still go the wrong direction, making it impossible to tell whether an additional 30% sell-off from here would actually be the bottom. If the stock market continues to decline that much, he doesn’t know what he’ll do.
There is always money to be made in choppy markets — after all, there are two sides to every trade — but bear cycles like this one are especially dangerous because they can turn around violently. Not only do investors have to worry about stocks cratering all around them, but they also have to be ready for face-ripping rallies that can appear like storms out of nowhere and leave all but the most nimble investors behind.
The markets have turned into an advanced adult swim. Unless you are a seasoned practitioner, I suggest you avoid looking at your 401(k) until next year. No one really knows where the bottom is, and no one really knows what’s going to happen next. This summer, the market is melting, and investors big and small are going to get burned before it’s over.
The heat keeps rising
For the past 10 years, Wall Street’s summers have generally been free and easy. Driven by low interest rates, cheap debt, and a stable economy, stocks have been on a decadelong upswing with few hiccups along the way. And during the pandemic the market went absolutely bonkers. Investor enthusiasm and the sudden injection of stimulus checks pushed the boom to the point that just about any company could go public, even a New Jersey deli. The markets hit record highs seemingly daily. Stock promoters like the venture capitalist Chamath Palihapitiya and the tech investor Cathie Wood gained TikTok-influencer status among enthusiastic retail investors. Wood and Palihapitiya encouraged their followers to throw away finance’s silly rules about cash flow and debt and to bet on long-shot companies with emerging (often questionable) technology. Wall Street — which never lets a good fad go to waste — forgot itself as well. The money sloshing around in all this goofiness was too good to pass up.
But all that changed over the past six months — and the market has gone from free and easy to a chaotic mess. This level of destruction feels stunning, but it really shouldn’t: Wall Street always knew this day would come. Investors have talked about it incessantly for years. It’s just that, as with the rapture, no one knew the hour or the day. We also didn’t know how savage it would be when it arrived.
Inflation did not appear in America quietly or subtly. It started rising in earnest in the summer of 2021 and recently hit levels unseen since the 1980s. The consumer price index reached 8.3% in April — a bit down from recent records, but still more than four times what the
Federal Reserve
wants. As a result, the Fed has little choice but to raise interest rates, a move that may be good for the economy in the long run but would crush stocks in the interim.
The pressures pushing up prices are also coming from around the world. China has imposed widespread pandemic lockdowns in cities including Shanghai, home of the world’s biggest port, which is experiencing major delays. Throw in a trucking problem and factory closures and what you get is a massive drop in exports and higher prices for US consumers.
“Now people are asking on conference calls which part of your supply chains are in China,” Justin Simon, a portfolio manager at Jasper Capital, told me. “From a geopolitical standpoint I think that’s really interesting.”
Weibo, Getty Images
The heat from abroad is coming not just from China. Russia’s attack on Ukraine is putting pressure on the prices of food and energy supplies, adding uncertainty to what are already the most volatile components of inflation. Russia’s new pariah status is also making companies and investors reconsider where and how they do business. The theory that by trading with a country the US can make it more democratic has fallen by the wayside, so politics have to considered. We do business only with our friends now. Instead of hyperefficiency — putting factories in any country, no matter its domestic politics, as long as it makes production cheaper — investors now want more control and redundancy in the supply chain, so that one broken link doesn’t throw off an entire system.
The world of banking is well aware of this shift. JPMorgan CEO Jamie Dimon told Bloomberg that “the Cold War is back” and that we need more coordination with our allies “not just for military purposes but for global, economic, strategic investment purposes.” Bringing pieces of the supply chain back to the US that we once sent abroad — defense contractors and metals and fertilizer and oil — will be expensive. But it’s worth the expense.
“You know there are supply issues coming, but you don’t know where they are,” said the seasoned investor, who also oversees industrial and manufacturing companies. “It’s all of this whack-a-mole shit where you don’t know which part of the supply chain will be screwed up.“
Amid the raging inflation, supply-chain bedlam, and geopolitical pressure, Chairman Jerome Powell and the Federal Reserve are doing their best to slow runaway prices. The Fed raised interest rates by 0.5 points in early May — the first half-percentage-point hike in 22 years — and signaled that more big hikes are on the way. The idea is that higher interest rates will make it more expensive for businesses and households to take out loans, slowing the economy and cooling off price increases.
The stomach-churning question is whether the Fed can do just enough of this easing without tipping us into recession. It was already going to take an Olympic gymnast’s level of balance and skill to stick this landing. Now, with the war in Ukraine and the pandemic’s grip on China, it’s as if the gymnast’s balance beam has been greased and there’s been an oil spill on the mat.
Some of these are short-term challenges. But some are not. The European Union seems determined to wean itself off Russian gas. Globalization is being rethought, especially in the technology and defense sectors. And the US’s relationship with China is only getting colder. All of that requires a fundamental restructuring of financial machinery — of where money flows and why. Those sorts of recalibrations don’t come easy, and they usually cause a lot of pain along the way.
This is the kind of market that turns geniuses into idiots
In this environment, some investors, like Simon, the portfolio manager at Jasper Capital, prefer to take some cash out of the market and wait. He’s up double digits in the year to date. “I really hit it this spring,” he said, “because I was long oil and gas and I was short Cathie Wood.” (That is to say, he was short the early-stage tech companies she bets on.)
Wood’s flagship ETF — which returned 156% in 2020 — is down 75% from its record high and about 60% this year. In other words, Simon got ahead of one of the key pieces of the market’s meltdown: the tech collapse. For years Wall Street’s returns have been bolstered by a tech gold rush that relied on low interest rates and cheap debt to fuel companies that promised grand visions of the future but made no profits. But in a world where borrowing money costs more, dreams of a far-off future don’t matter nearly as much as cold hard cash in the present.
“Tech is a flywheel,” Simon explained. “When money comes in, Silicon Valley hires up, and companies start using each other’s services. They are all users of each other’s technology — premium LinkedIn accounts, buying Apple computers, using Salesforce, housing their data at Amazon.” But now that intermingled success is turning into an industrywide tailspin.
Patrick T. Fallon/Getty Images
It’s not just the Woods of the world getting slammed by the tech destruction. In April, Bill Ackman, a Wall Street golden boy who runs Pershing Square Asset Management, announced that he had lost $400 million on his investment in
Netflix
— a position he’d announced just three months earlier to much fanfare.
In what was essentially a non-apology apology letter to clients, Ackman explained that there was nothing wrong with Netflix’s product or its management. Conditions (interest rates) just change, and, Ackman wrote, “in light of recent events, we have lost confidence in our ability to predict the company’s future prospects with a sufficient degree of certainty.”
Like a lot of tech companies experiencing extreme trauma in the stock market, Netflix has always relied on user growth to impress investors. But it has never really made money. Companies like this were the darlings of the past decade-plus. Money was so easy to borrow that they didn’t have to make any. They could just take on debt and show investors how much they were growing.
“The kiss of death for tech is when tech starts talking profitability — then the tide goes out and you’ll figure out who’s been swimming naked,” Simon said.
And profitability is what Silicon Valley is talking about right now. Uber’s CEO basically gave a sermon about it last week and said that going forward hiring would be a “privilege.” Meta is having a cost-cutting push. And so many
fintech companies
are having layoffs, it’ll make your head spin. Even some of the most resilient tech giants are taking it on the chin — Apple just lost its status as the most valuable company in the world and is down 20% for the year.
This is not a drill. A whole lot of money just evaporated, and a lot more is probably about to disappear along with it.
Have a great summer, Wall Street
In a market move as dramatic as this one, investment firms (especially big ones) can get trapped like a deer in headlights. Theoretically, they could just start buying other assets, but that’s not how Wall Street works in practice. It is not easy for an investment firm to just change its strategy. For one thing, clients bought in because of the strategy you were selling — they like to see more of what’s working.
For another, finance guys buy what they know. And right now a lot of Wall Street is staffed by people who know how to make money on high-growth, cash-poor tech stocks. They do not know a world where companies have to make money to be valuable. They know how to value tech companies, not energy companies. They know about software, not supply chains. This is the kind of moment for which the phrase “adapt or die” was invented, and that adaptation could take years, not weeks or months.
In Pictures Ltd./Corbis via Getty Images
For most of the financial world, this summer will be about long hours and mitigating losses. Last year risk managers and prime brokers (bankers who service financial firms) could probably spend the summer in the Hamptons. This year they will need to spend time in the office, putting out fires and watching their clients’ portfolios get blown to smithereens. Sometimes that’s the job.
I don’t blame you at all if you don’t feel the least bit sorry for any of these billionaires or the millionaires who work for them. And perhaps you have the time and discipline to ignore your 401(k) until the market bounces back — that would be wise. But consider, if you can find it in your heart, the retail investors who got into the market while they thought the getting was good and are now getting creamed. They might not have been the most informed investors, but they were mostly just regular people. And according to Morgan Stanley, they’ve lost all those returns. In a telltale sign that the party is over, Robinhood, the once ubiquitous trading app, is going through a round of layoffs, and crypto is getting slaughtered too (don’t say we didn’t warn you there).
There are three ways this can end. The Fed could pull off its Olympian balancing act, meaning the US would see a brief period of slower growth but inflation would recede and things would go back to normal (whatever that means now). Another option is stagflation — that means the Fed’s interest-rate hikes are unable to tame inflation but the economy still slows, leading to a double whammy of high prices and miserable unemployment. Lastly, interest-rate hikes could seize up lending in the US, screw up our currently robust jobs market, and push us into a recession.
Two of those three options are painful, but there’s little for Wall Street (and everyone else) to do in the interim except sweat it out. That powerlessness is what makes this moment so hellish, but try not to fret. The next market we meet will offer opportunities for all kinds of investors. Unfortunately, in the meantime, we have to watch this market burn.
Linette Lopez is a senior correspondent at Insider.
