Benchmark stock indexes in Canada and the U.S. suffered their biggest one-day percentage drop in more than two months on Wednesday, as investors reacted to data showing the largest jump in inflation in the world’s biggest economy since 2008.
The stronger-than-expected reading sent bond yields higher and agitated market participants who have grown increasingly worried over whether current price jumps will defy the U.S. Federal Reserve’s reassurances by morphing into long-term inflation.
The selloff across sectors was broad, but a rally in the price of crude oil fuelled gains in energy stocks, limiting the drop in the S&P/TSX Composite Index to less than half of the major U.S. indexes on a percentage basis. Tech giants, which had soared during the past year of lockdowns, took some of the biggest losses on Wall Street. But the selloff this week is extending beyond growth stocks, with the S&P 500 flirting with its worst weekly drop since October.
Pent-up demand from consumers flush with stimulus and savings is colliding with a supply drought of raw materials, sending commodity prices spiking, while a labour shortage in the U.S. is driving wages higher.
“The topic on everyone’s mind is obviously inflation,” said Matthew Keator, managing partner in the Keator Group, a wealth management firm in Lenox, Massachusetts. “It’s something the (Fed) has been looking for and they’re finally getting their wish.”
“The question is how long will its fires run hot before starting to simmer?”
That concern is shared by Stuart Cole, head macro economist at Equiti Capital in London.
“Going forward, the big question is just how long can the Fed maintain its dovish stance in opposition to the markets,” Cole said. “Particularly if companies begin raising wages to encourage unemployed labor back into the workforce, in turn driving a large hole in the Fed’s transitory inflation argument.”
The Consumer Price Index climbed 4.2% during the month, from a year earlier, the Labor Department said, the fastest pace since 2008. From March to April, prices increased 0.8%. Economists had expected the CPI to rise 3.6% over the year, and 0.2% from the month before.
The core index, which strips out volatile food and energy prices, rose 0.9% in April from March — its biggest monthly increase since April 1982. It climbed 3% over 12 months, shooting above the central bank’s average annual 2% inflation growth target.
Investors’ tendency to look past minor wobbles in stocks as the S&P 500 rallied about 90% over the past year or so has been a key feature of the equity market since it rebounded from March 2020 pandemic lows and has helped make market pullbacks shallow and brief. That, however, may be changing.
Traders have been placing more bearish bets on equity derivatives in recent days, data showed on Wednesday, indicating less confidence in U.S. stocks rebounding from a sharp sell-off which has particularly hit high-flying tech names.
Rather than positioning for a quick rebound, as they have typically done in recent past, traders in the options market are laser-focused on defensive plays.
“The really irrationally bullish equity options traders that I have been warning about for a long time have finally gone away,” said Randy Frederick, vice president of trading and derivatives for the Schwab Center for Financial Research.
Options market measures, including skew - a gauge of demand for upside vs downside - show investors extremely concerned about further weakness for U.S. stocks.
There are few takers for upside bets in equity index options even as defensive options remain in high demand, Charlie McElligott, managing director, cross-asset macro strategy at Nomura, said in a note.
For S&P 500 options, the 30-day implied-volatility skew is higher than it has been 87% of the time over the past 52 weeks, data from options analytics firm trade alert showed.
On Tuesday, the trading in S&P puts - contracts often used for bearish bets - outpaced that in calls - options used for bullish wagers - by a margin of 2-to-1, the highest this measure has been since February. The ratio was similarly high on Wednesday.
The S&P/TSX Composite Index closed down 166.27 points, or 0.86%, at 19,107.77. The materials sector took a particularly harsh bruising, losing 2.2%, as gold prices fell due to a surge in the U.S. dollar making the commodity less attractive to global investors. U.S. gold futures settled down 0.7% at $1,822.80.
The energy sector gained 1.33% as oil prices rose to an eight-week high amid data showing inventory drawdowns in the U.S. and fresh forecasts for energy demand. .
U.S. West Texas Intermediate (WTI) crude rose 80 cents, or 1.2%, to settle at $66.08. That was the highest close for Brent since March 11 and for WTI since March 5.
The International Energy Agency (IEA) said in its monthly report that oil demand is already outstripping supply and the shortfall is expected to widen even if Iran boosts exports. Similarly, the Organization of the Petroleum Exporting Countries (OPEC) on Tuesday stuck to a forecast for a strong recovery in world oil demand in 2021, with growth in China and the United States outweighing the impact of the coronavirus crisis in India.
The Dow Jones Industrial Average fell 681.5 points, or 1.99%, to 33,587.66, the S&P 500 lost 89.06 points, or 2.14%, to 4,063.04 and the Nasdaq Composite dropped 357.75 points, or 2.67%, to 13,031.68.
Of the 11 major sectors in the S&P 500, 10 closed in negative territory, with consumer discretionary down most. Energy was the sole gainer, advancing 0.1%, boosted by rising crude prices.
The CBOE Volatility index, a gauge of market anxiety, close at 27.64, its highest level since March 4.
First-quarter earnings season is on the wane, with 456 constituents of the S&P 500 having reported. Of those, 86.8% have beaten consensus estimates, according to Refinitiv IBES.
In the bond market, the yield on 10-year U.S. Treasury note was up 7.1 basis points by late afternoon to 1.695%, its biggest one-day basis point increase since March 18. Canadian yields also rose, with the closely watched five-year bond up 5.9 basis points 0.969%. That’s still below the 1.072% it reached in March.
With files from Reuters
Reuters, Globe staff
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