Stocks see worst wipeout since 2022. Here's what might happen next.

By Joseph Adinolfi

Investors say pullback isn't over yet, but will ultimately present a buying opportunity

It was wipeout Wednesday on Wall Street, as a long-anticipated summer squall finally arrived to buffet stocks.

By the time the dust had settled after the closing bell, the S&P 500 SPX had shed 2.3% - its first pullback of 2% or more in 356 trading days. That ended the index's longest such stretch since 2007, according to Dow Jones Market Data.

See: Stocks are headed for a 'summer squall,' Citi warns

The tech-heavy Nasdaq Composite COMP fared even worse, falling 3.6% for its worst day since October 2022 and ending a stretch of more than 400 days without a decline of 3% or greater.

Selling accelerated throughout the day, leaving most of the major indexes to finish at or near their lows of the session.

Selling pressure was most intense for technology stocks and sectors with heavy exposure to megacap stocks, like consumer discretionary and communication services. The "Magnificent Seven" stocks fell 4.6%, based on a capitalization-weighted gauge of their performance from Dow Jones Market Data. But by the end of the session, even recent outperformers like small-cap stocks had succumbed.

Notably, the pain wasn't limited to stocks. Yields on longer-dated Treasurys climbed while yields on shorter-dated notes fell, causing the yield curve to re-steepen. Bond prices move inversely to yields.

Investors said weak data on the housing market and alarming comments from former New York Fed chief Bill Dudley - who called for the Federal Reserve to cut interest rates next week to stave off a potential recession - were partly to blame for the market pain.

Dudley's warning about the economy appeared to resonate, according to Kristina Hooper, chief global markets strategist at Invesco.

"I think there is a little more to this. More cracks are appearing in the economy and investors are becoming a bit more jittery," Hooper said during an interview with MarketWatch.

But Dudley's commentary were not the only catalyst. Earnings from a trio of key U.S. companies also contributed to the selloff, as Visa Inc. (V) offered fresh warnings about the strength of the American consumer, while Alphabet Inc.'s (GOOGL) (GOOG) results fueled concerns about its aggressive investment in artificial-intelligence-related infrastructure, according to Kim Caughey Forrest, founder and chief investment officer at Bokeh Capital Partners.

Tesla Inc. (TSLA) also reported a 40% drop in profits, causing the stock to fall more than 12% in its worst day since 2020 - though the company's results had little relevance for the broader market, Forrest and Hooper both said.

See: 'Magnificent Seven' stocks near correction territory as $1.7 trillion in value erased

But both Tesla and Alphabet contributed to the extreme weakness in shares of the Magnificent Seven stocks, a group of megacap companies seen as most likely to benefit from the artificial-intelligence revolution. The companies shed a combined $768 billion in market value - their biggest daily drop on record, according to Dow Jones Market Data.

Meanwhile, two of the three sectors where Magnificent Seven members are most heavily represented - information technology XX:SP500.45 and consumer discretionary XX:SP500.25 - each saw their worst day since September 2022 and were down 4.1% and 3.9%, respectively.

More stocks succumbed to the selloff as the day dragged on. Even the small-cap Russell 2000 RUT finished down 2.1% following a burst of outperformance in July. However, it remains up more than 7.2% so far this month, FactSet data show.

But a few bright spots remained. The S&P 500 utilities sector XX:SP500.55 rose more than 1%, while healthcare XX:SP500.35, energy XX:SP500.10 and consumer staples XX:SP600.30 stocks also finished higher.

Large-cap value stocks were also largely spared from the carnage, with the SPDR Portfolio S&P 500 Value ETF SPYV down just 0.3%, at $49.99. But other beneficiaries of the July rotation trade didn't fare as well, with the Dow Jones Industrial Average DJIA off by 504 points, or 1.3%, sliding back below 40,000.

The question now plaguing investors is how much longer the selloff can continue. Gene Goldman, chief investment officer at Cetera, said the selloff had been widely anticipated, and could even be construed as healthy for markets, given large-cap stocks' lofty valuations.

Furthermore, the rotation away from megacap names and into more affordable corners of the market could help to ease concerns about market concentration. However long it lasts, the selloff will ultimately present another opportunity for investors to buy.

"I was telling our advisors that the market was due for a pullback, look at the combination of high valuations of the stock market, high expectations and high concentration," Goldman told MarketWatch over the phone on Wednesday.

He said he expected a repeat of a similar pullback that happened last year, which saw the S&P 500 briefly fall into correction territory in October after peaking in late July.

Between now and the fall, plenty of risks remain. Many of the largest U.S. companies are due to report earnings this week and next. But perhaps the biggest focus for investors will be a meeting of the Federal Reserve next week. Many are hoping to hear Fed Chair Jerome Powell offer some indication that the central bank will start cutting rates in September.

If he does, it could help assuage investors' concerns, Hooper said. Although she added that the market is ripe for a pullback.

"I think it's more of a summer selloff because frankly we're due for one, we've had a really strong rally, and we've barely ad any kind of significant drop in a long time," she said.

"We have this catalyst on the horizon and its the start of Fed rate cuts. I think it'll be very supportive of stocks, and I would anticipate that we get messaging in advance of the September cut."

But Powell has demurred during other recent opportunities to more strongly signal that a cut is imminent, even as other senior Fed officials have started to call for one more forcefully.

More losses could be in store if investors aren't satisfied with his messaging next week, according to Mohannad Aama, a portfolio manager at Beam Capital Management.

"If the Fed statement isn't really indicative of a cut in September, I think we'll see a continuation of the selloff," he told MarketWatch on Wednesday.

The S&P 500 has now erased all of its gains from earlier in July, but it remains up 13.8% year-to-date. The Nasdaq is now off 2.2% this month, but is still up 15.5%.

For now, there are signs traders are bracing for more pain in the near term. The Cboe Volatility Index VIX, better known as the Vix or Wall Street's "fear gauge," rose 22.5% to 18.04, its biggest gain since June 2022, Dow Jones data show.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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07-24-24 1810ET

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