Several of Wall Street's largest trading operations had spent weeks predicting that the stock market would climb once the election concluded. On Thursday, that prediction failed dramatically.
Trading teams at JPMorgan Chase & Co., Citadel Securities, and UBS Securities had described the midterm elections as a decisive moment for markets that had been tense leading up to the vote. They argued that with substantial cash waiting on the sidelines, investors would be motivated to re-enter and rebuild their positions.
Stocks did rise on Wednesday after Democrats achieved sweeping victories, but fears surrounding the artificial intelligence sector erased $2.3 trillion from the Nasdaq 100 Index the following day. The S&P 500 fell 4.4%, with every sector ending the session lower.
Naturally, a single trading session does not establish a market trend, and the bullish outlooks from trading desks may yet prove correct. However, Thursday's sharp decline underscores how difficult it is to predict the stock market's direction, even for Wall Street's professionals.
On Wednesday, Goldman Sachs Group Inc.'s equities trading desk experienced one of its busiest days of the year, according to John Flood, the bank's head of Americas equities execution services. Thursday was "the exact opposite," he wrote in a note to clients. "Our phones are exploding with asks for color. Unfortunately we aren't seeing much."
The long-only investment community was "frozen" once again, he said in the note. Investors had aggressively cut their stock exposure ahead of the midterms and were surprised by Wednesday's rally, he added. Hedge funds were now selling some of the AI hyperscaler stocks they had purchased just the day before.
Optimism Before the Election
The bullish forecasts before the vote had been based on the notion that investors were positioned so defensively going into the election that removing the uncertainty could prompt them to rebuild their exposure. Hedge funds, for example, sold stocks in October at the fastest pace since March, according to data from Goldman's Prime Services desk.
Citadel Securities' Scott Rubner, head of equity and equity derivatives strategy, said the election could help pave the way for a year-end rally. "With the election behind us and volatility potentially normalizing, there is considerable capacity for investors to rebuild risk," Rubner wrote in a note to clients on Wednesday. "With uncertainty fading and several of the market's largest buyers returning, we believe the path of least resistance for US equities is higher into year-end," he said.
UBS Securities' Davide Montoni similarly argued that the vote could serve as an upside catalyst after a turbulent period for technology stocks. "Hyperscaler earnings clearly did not provide the all-clear investors were hoping for, but getting through the election could be the catalyst that unlocks a year-end squeeze," he said.
JPMorgan's trading desk also expected technology stocks to recover and the rally to extend beyond a narrow set of megacap stocks. The bank's US Market Intelligence team said it was tactically bullish, contending that the recent tech selloff had created an opportunity for a near-term bounce.
But the election did little to resolve the other forces weighing on stocks.
Barclays Plc's global head of equities tactical strategies, Alex Altmann, was one of the few skeptics among Wall Street's major trading desks. He had warned that the midterms were unlikely to be the decisive moment investors were seeking, since the biggest pressures on equities, such as AI's payoff and the cost of financing its buildout, would not be resolved by the vote.
Systematic Flows Increase Pressure
The magnitude of Thursday's decline was amplified by so-called systematic strategies, many of which follow the stock market's direction rather than fundamental drivers.
Volatility-control funds could cut equity exposure by about 30 percentage points, one of the largest single-day adjustments since the market turmoil of the Covid era, according to Barclays Equities Tactical Strategies models. Those funds could sell roughly $135 billion in US equity futures over the next 24 to 48 hours, the models indicate.
"We expect this to continue tomorrow as unwinds spread through the real money channels of retail and Long Only investors," Altmann added.
ETF rebalancing contributed additional pressure. Thursday was estimated to be the largest-ever levered ETF rebalance for sale, Barclays noted.
Retail investors, another source of demand during previous market dips, were hesitant to step in. Retail traders were on pace for their largest day of selling in individual stocks since the Covid-19 pandemic, Vanda Research said. As of 3 p.m. in New York on Thursday, they had sold a net $338 million of single stocks, according to the firm.
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