Must See Charts: Stocks Record Highs, Smart Money Turns Cautious

The Federal Reserve delivered its September rate cut, fully priced in by markets. U.S. equities hit new record highs, but caution may now be warranted as some investors shift defensive.

Historically, when the Fed conducts “preemptive cuts,” equities usually perform well. By contrast, during recessions, “rescue cuts” have sparked market panic. In 2020, the Fed’s aggressive rate cuts in response to the pandemic triggered a sharp market selloff.

Although the U.S. labor market has weakened substantially, the economy has not shown steeper downturn signals. The FOMC’s latest economic projections even revised GDP and inflation forecasts higher.

Future positive growth data and recession avoidance are unlikely to push growth expectations further up — instead, they may lead to a hawkish policy repricing. That would pressure rates higher and weigh on equity valuations.

If a mild recession proves unavoidable, when genuine recession risks surface — combined with still-elevated inflation — markets could face major downside risks. Current extreme valuations would only amplify the intensity of any decline.

The current market logic rests on a fragile balance: not enough bad news to trigger recession, but sufficient weakness to justify Fed rate cuts and lower interest rates, supporting equities. This dynamic has driven valuations near historic highs, with some metrics at record levels. At such stretched valuations, any negative shock could spook investors sharply.

Some “smart money” is already hedging against downside in tech stocks. The cost of hedging a 10% drop in QQQ ETF is near the highest since 2022. Demand for downside hedges is rising, signaling growing investor caution.

Speculators’ total positioning in U.S. equity index futures turned net short for the first time since late 2023, though net long exposure remains heavily concentrated in technology stocks.

So far, volatility gauges have not sounded alarms, with the VIX still below 16. Yet nervousness is spreading beyond big tech. Some traders are buying S\&P 500 put options. Put/call ratios have climbed to the highest since May, but put options remain cheap. For now, hedging U.S. equity downside looks worthwhile.