Another day, (maybe more than just) another rout

Good morning. US stocks got taken out to the woodshed yesterday. The S&P 500 fell 2.7 per cent and the Nasdaq fell 4 per cent, its biggest one-day fall since 2022. A few things are clear. US growth and tariff policy are major concerns for investors at a moment when the country’s risk assets are very expensive. Inflation risks remain on the table. And the Trump administration’s “short-term pain, long-term gain” rhetoric about markets and the economy has scared everyone out of their trousers. Beyond that, it is hard to say much definitively. We try to find some order in the chaos below. If there are points we have missed, email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

Anatomy of a rout

When stock markets really panic, analysis can only take you so far. Logic fails and emotion takes control. That said, there are some patterns in yesterday’s rout which — if confirmed in the days to come — will tell us something about what is going on.

Monday looked like a worse case of the same illness the market suffered from last week. Big tech was hardest hit, led by Tesla (15.4 per cent down), Microchip Technology (10.6 per cent) and Palantir (10.1 per cent). Even Apple, the most defensive of the Mag 7, which has held up relatively well over the past month, was off by almost 5 per cent. Banks were down hard, too, showing that investors are concerned about growth, and that the recent hopes that this would be a good year for trading, capital markets and deregulation have been dashed.

Defensives did well overall, especially in healthcare and staples. Utilities finished the day up. On its face, this looks like a flight to safety, as investors rush to take profit in the stocks with the biggest gains over the past few years. But there are several aspects of the market action we still don’t quite understand.

Why didn’t bonds rally more? The price on a 10-year Treasury bill was only up 10 basis points at the end of the day. We would have expected more given the size of the move in equities. Was the rally restrained by fears of rising inflation? Perhaps not — break-even inflation was down a touch, and the term premium up a little.

Also, why did some cheap cyclical stocks do OK? General Motors, Ford and 3M were all up at the end of the day, for example. Meanwhile, staples fortresses Walmart and Costco were well down. Their decline probably has more to do with people selling stocks where they have seen gains or were overweight — both Walmart and Costco have had great runs over the past year or two. But the growth scare figures in here, too.

Today we will be watching for signs that we are seeing an adjustment rather than the start of a full-on bear market. Do investors buy the dip, and if they do, will the sellers rush back in? Tomorrow’s close will be particularly interesting in this respect. Signs of a bigger flight into bonds will be important, too. Severe contagion to international stock markets will tell us something about whether what we are seeing is the reversal of the overcrowded US trade or something much worse — a global flight from risk. And, like everyone else, we will be looking for any signal that the White House will moderate its policy approach in the face of market mayhem.

Germany and Europe

As US assets start to crack, Europe’s entire financial system may be changing fundamentally.

Last week, Germany’s chancellor-in-waiting Friedrich Merz announced that his government would circumvent the country’s long-standing debt limits to boost defence and infrastructure spending by up to €500bn. Then the European Commission said that it would also push forward a €150bn defence funding loan scheme. Other plans are also being floated, including seizing Russia’s frozen assets and, most radically, issuing special defence Eurobonds. Bond yields have jumped and banks have upgraded their growth forecasts for the continent, and all of this has pushed the Euro higher against the dollar:

At the same time as the fiscal chessboard has been rearranged, European stocks have performed strongly this year, even as US indices tumble. The fiscal boom and the equity rally appear to be closely linked. But they are not one and the same. Some points to bear in mind:

The European rally: The shifting fiscal outlook has some investors seeing a secular growth story, with carry-over to the stock market. Though that may be true, Europe’s outperformance started a month before Germany’s big announcement. This has been more about rotation away from the US, says Thierry Wizman, chief FX strategist at Macquarie Group:

European growth will do better overall than it otherwise would have, in light of the government spending. But unless that spending is directed broadly towards Europe’s private sector, it does not necessarily bode well for European stocks . . . higher sovereign bond yields will pressure multiples lower, and crowd out some private-sector led growth, especially if compounded by worries about sovereign debt rising too fast . . . What is happening in European stocks still feels like a rotation out of the US, rather than [being] supported by European fundamentals on their own merits.

Some of the biggest moves in European shares are, indeed, tied to European defence and the secular growth narrative. Defence companies have carried the market for the past two weeks, and banks have done extremely well. But, zooming out, this is a wide rally, and it does not cut cleanly across defensives and cyclicals: