Why the US market suffered its worst day since 2022

The S&P 500 suffered its worst day since December 2022 last night, ending a remarkable 365-day streak without a 2% decline amid a sharp selloff for heavyweight tech stocks like Tesla and Alphabet.

Major indices tumbled across the board, with the S&P 500 dropping 2.3% and the tech-heavy Nasdaq plunging 3.6%, marking its steepest fall since October 2022. The blue-chip Dow Jones Industrial Average showed relative resilience, declining a comparatively modest 1.25%, as investors sought refuge in defensive sectors.

Selloff drivers

Alphabet down 5.0% on earnings: Google parent company Alphabet reported second-quarter results that were slightly ahead of analyst estimates. Alphabet's Q2 revenue for the year was up 14% year-on-year to US$84.7 billion vs. the US$84.2 billion consensus while earnings per share lifted 31% to US$1.89 per share vs. the US$1.84 per share expected. However, two factors weighed on the stock:

• Youtube: Youtube ad revenues of US$8.6 billion missed analyst estimates of US$8.9 billion amid growing competition from sites like TikTok and decelerating ad trends

• Capex: Q2 capex came in at US$13.2 billion, more than US$1 billion above consensus and up more than 90% year-on-year. Management warned that Q3 operating margins will come under pressure amid "increases in depreciation and expenses associated with higher levels of our investment in technical infrastructure."

Tesla down 12% on earnings: The electric vehicle maker experienced its steepest decline since September 2020, reporting a 45% drop in Q2 net income. Average selling prices fell 13% quarter-on-quarter and 27% year-on-year, eroding crucial margins. While Q3 production forecasts increased, the company cautioned that vehicle deliveries would likely remain lower year-on-year.

High bar for Q2 earnings season: The market is looking for Q2 S&P 500 earnings growth of around 8.8%, according to FactSet. Big tech remains the key tailwind, with Goldman Sachs suggesting that the six largest stocks (Amazon, Apple, Alphabet, Meta, Microsoft and Nvidia) are expected to grow earnings by 30% year-on-year, compared to just 5% for the remaining 494 S&P 500 companies.

Yield curve: The US yield curve steepened sharply overnight, with the spread between 2-and-10 year Treasury yields narrowing to about 14 basis points, the smallest since October 2023. This suggests market expectations of faster and more aggressive Fed rate cuts than previously anticipated.

On the bright side: Four S&P 500 sectors managed to finished higher: Utilities (+1.1%), Health Care (+0.8%), Energy (+0.2%), and Staples (+0.04%). This underscores the recent trend of rotating into cyclical and defensive sectors, driven by disinflation momentum and growing soft landing expectations. More specifically, 165 S&P 500 stocks closed higher. This marks the most number of advancing stocks for a -2% day over the past 10 years, according to Optuma.

What does history tell us?

Since 1928, the S&P 500 has experienced 12 periods where it went 300 or more trading sessions without a daily loss of 2% or more, according to SentimenTrader.

After this signal, the average one month, three month and twelve month returns were 1.7%, 3.0% and 6.8% respectively.

"At any point within the next 6 months, only 1 signal (1957) suffered more than an -8% drawdown. Over time, 3 of them morphed into serious bear markets," says SentimenTrader founder Jason Goepfert.

Source: SentimenTrader

The ASX is down 1.2% at noon and on track to log its worst session since 11 June. Every sector is trading lower, but defensives like staples, health care and industrials are outperforming on a relative basis.