The US stock market experienced its most severe fluctuation since 2019 in one week.

This week, although the U.S. stock market remained flat overall, the trend was like a roller coaster. On Monday, there was panic selling, followed by a strong rebound on Tuesday. On Wednesday, technical selling pressure caused another decline. On Thursday, a drop in initial jobless claims triggered a bottom-fishing rally, and on Friday, the rebound continued but with weakened strength.

In the past week, the stock market and the cryptocurrency market have been closely linked. Media discussions about a U.S. recession and the unwinding of yen arbitrage trades have been heated, but this may be a "pseudo proposition." The real panic was quite short-lived, and there was no widespread selling commonly seen during a crisis.

After the sell-off in the US stock market on Monday, there was a peak-to-trough fluctuation of about 4.5%, marking the largest weekly fluctuation since the COVID-19 crisis in 2019. Significant fluctuations indicate both risks and opportunities. The sell-off during Monday's trading may have been an unexpected overreaction, with reasons including:

• Most US economic data is positive, with only a few indicators supporting the recession argument.
• The growth in corporate profits is good, but the extent of the outperformance has not expanded.
• Japan finds it difficult to sustain interest rate hikes
• High leverage positions were basically closed on Monday.
• Fixed income and foreign exchange market trends do not align with panic or liquidity shortage characteristics.

However, market sentiment needs to be further observed. Capital preference has not yet shifted from defensive to aggressive, and disappointment in large technology stocks has escalated to the level of "kill narrative." In the coming months, the Dow and S&P may outperform the Nasdaq, but cyclical stocks may rebound more sharply in the short term.

The rise in bond prices has provided a buffer for the stock market. The yield on the U.S. 10-year Treasury bond has fallen from 4.5% to 3.7% in a month, a decrease of 80 basis points that far exceeds interest rate cut expectations. Unless a recession is imminent, this pricing may be excessive. In recent years, the market seems to be more "animalistic" than ever, with pricing being less rational.

The stock market adjustment started from a historical high, with a maximum decline of about 8%, but is still 12% higher than the beginning of the year. Considering the rise in bonds, diversified investors are minimally affected by the decline in the stock index. Historically, there are an average of 3 adjustments of more than 5% and 1 adjustment of 10% each year.

Market adjustments without economic or corporate profit recessions are often temporary. However, the pessimism surrounding tech stocks is difficult to reverse quickly, and the severe fluctuations have damaged many portfolios, leading to a continued need for adjustments in medium to long-term funds. Short-term fluctuations may not have fully ended, but the likelihood of a significant deep decline is low. The strong rebound in the latter half of last week is a positive signal.

Analysis of September Interest Rate Cut Expectations

According to the Taylor rule, the Federal Reserve's target interest rate should be around 4%, which is 150 basis points lower than the current rate. The Federal Reserve has reason to quickly adjust its policy to accommodate the current economic conditions.

The market expects that the interest rate cut in September may exceed 25 basis points. This week, the market is pricing in a total rate cut of 100 basis points within the year, with ( four times ). The expectation of more than 25 basis points and more than three cuts within the year needs continuous deterioration of data such as employment to support it; otherwise, it may be excessive.

In the short term, the U.S. interest rate market is mainly characterized by a rise followed by a correction, while in the medium term, it is in a buy-the-dip mode. The market needs time to reach a consensus on whether the rise in unemployment rate indicates an economic slowdown and potential recession, during which sentiment may fluctuate.

Federal Reserve officials spoke slightly dovish last week but overall remained non-committal, which was in line with expectations.

Cryptocurrency Market Analysis

Bitcoin has experienced its most dramatic pullback since the FTX crisis, rebounding after a drop of over 15%. This pullback is due to external shocks from traditional market adjustments and internal events in the non-crypto market. The technical indicators are severely oversold, approaching the levels seen on August 16 of last year.

Retail investors play a significant role in the adjustments. In August, the outflow of funds from Bitcoin spot ETFs reached a record high. In contrast, the de-risking behavior in the US futures market is limited, as the changes in CME Bitcoin futures contract positions and the positive basis indicate that futures investors remain optimistic.

Bitcoin dropped to around $49,000 last week, close to the production cost estimated by JPMorgan. If this level or lower is maintained for a long time, it will put pressure on miners and may further depress prices.

Factors keeping institutional investors optimistic include:

• Morgan Stanley allows the recommendation of Bitcoin spot ETF
• The liquidation pressure from the Mt. Gox and Genesis bankruptcy cases may have passed.
• The payment after FTX's bankruptcy may stimulate demand by the end of the year.
• The two major parties in the US may support favorable cryptocurrency regulations.

Capital and Position Status

Despite the recent reduction in stock allocation due to price declines and increased bond allocation, the current stock allocation ratio of (46.5%) is still significantly higher than the average after 2015. To return to the average level, stock prices need to drop further by 8%.

Investors have very low cash allocation, with more funds concentrated in stocks and bonds. This may increase market vulnerability, as investors may be forced to sell assets to obtain cash during downturns, exacerbating Fluctuation.

Recently, bond allocation has increased significantly as investors turn to bonds for safety during the stock market correction. Retail investors have reacted relatively mildly, with no large-scale withdrawals occurring. Retail investor sentiment surveys still lean towards positivity.

The changes in Nikkei futures positions indicate that speculative investors have significantly reduced their long positions. The speculative net short positions in yen have basically returned to zero as of last Tuesday.

"Yen Arbitrage Trading" Scale Analysis

Yen arbitrage trading mainly includes three parts:

1. Foreign investors purchase Japanese stocks and short equivalent yen derivatives, with a scale of about $600 billion.

2. Foreign investors borrowed yen to invest in overseas assets, approximately $420 billion at the end of the first quarter of 2014.

3. Domestic investors in Japan purchase foreign stocks and bonds with yen, with approximately $3.5 trillion before adjustment, 60% of which are foreign stocks.

The total scale is estimated to be about 4 trillion USD. If inflation in Japan forces the central bank to raise interest rates, such transactions may gradually decrease.

Summary of Investor Behavior

1. Trend Follower ( such as CTA ): Recently, there has been a large reduction in stock long positions and yen short positions.

2. Yen arbitrage trading: $4 trillion scale has not been significantly unwound.

3. Risk parity fund: reduces investment but to a lesser extent than CTA, with bond increases helping to control losses.

4. Ordinary retail investors: The amount of capital withdrawn during this stock market decline is relatively small.

Since the end of May, Chinese-themed funds have continued to attract passive capital, with an inflow of 3.1 billion USD this week.

Despite market fluctuations, equity funds saw a net inflow for the 16th consecutive week this week, with an increase, while bond fund inflows slowed. The allocation of both discretionary and systematic strategies has fallen below average for the first time since last summer's major pullback.

The VIX index experienced a single-day fluctuation exceeding 40 points, setting a record, yet the actual fluctuation in the stock market was less than 3%, indicating liquidity issues in the VIX market. The market may remain turbulent before the expiration of VIX options on August 21.

Goldman Sachs clients had net sales of product funds for the third consecutive week last week, while individual stocks recorded the largest net purchases in six months, particularly in the technology, consumer staples, industrials, communications, and financial sectors.

The liquidity of the US stock market is at its lowest level since May of last year. The Bank of America's CTA strategy model shows that in the coming week, US stock CTA funds are inclined to increase positions, while Japanese stocks are inclined to decrease positions.

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