S&P 500 slumps nearly 1.4% in worst day since April as Nasdaq falls over 2% after Fitch lowers U.S. credit rating

What drove markets

The U.S. stock market saw a sharp sell off on Wednesday as broad risk-off sentiment returned following weeks of gains fueled by the euphoria around artificial intelligence and hopes that the U.S. economy can avoid a recession as inflation falls.

The catalyst was a late Tuesday announcement by the rating agency Fitch that it was lowering the U.S.’s credit rating from AAA to AA+, citing “expected fiscal deterioration” and an “erosion of governance”.

The decision created uneasiness among investors already concerned about the risks of a recession as a result of the Federal Reserve’s monetary tightening, and whether this year’s stock-market rally still has room to run given rising valuations.

Fitch’s decision followed a similar move by S&P Global Ratings in 2011 after a previous fight in Congress over raising the debt ceiling. The U.S. Treasury market acts as a global benchmark upon which many financial products are based and so uncertainty about its stability can cause anxiety for investors.

See: Fitch cuts U.S. credit rating: Here’s what you need to know

The news found a stock market arguably vulnerable to unwelcome surprises, with the S&P 500 index having already gained 17.6% this year and the tech-heavy Nasdaq Composite up 33.5%.

The CBOE VIX Index, an option-based gauge of expected S&P 500 volatility, jumped 15.4% to 16.10, after hovering around 16.48, its highest level since May 31 earlier in the session, according to FactSet data.

“Markets will take some time to digest the news,” said Frank Lietke, executive director and president at Ally Invest Securities. However, he said he doesn’t expect the credit rating downgrade to cause the stock market much long-term damage. “We’ve seen this before,” Lietke said. “This alone won’t be enough to put significant downward pressure on stocks.”

Fawad Razaqzada, market analyst at StoneX, said when the S&P ratings agency downgraded the U.S. credit rating twelve years ago, the S&P 500 index fell about 80 points, or 6.6% the next trading day.

However, the sell-off in response to the 2011 ratings downgrade had come on the back of “an already-weak market,” with the index being in a downtrend. This time, the market is in a clear uptrend, which partly explains why we haven’t had a major sell-off yet, Razaqzada said.

See: How Fitch downgrade might impact Treasury’s $1 trillion third-quarter borrowing plans

Also earlier Wednesday, the U.S. Treasury published its August refunding statement. It said it is offering $103 billion of Treasury securities to refund about $84 billion of privately-held Treasury notes and bonds maturing in mid-August. The issuance will raise new cash from private investors of around $19 billion.

The yield on the 30-year Treasury 
BX:TMUBMUSD30Y
rose 6 basis points to 4.164% from 4.104% late Tuesday. The yield on the 10-year Treasury
BX:TMUBMUSD10Y
 advanced 2.9 basis points to 4.077% from 4.048% Tuesday afternoon.

The second-quarter earnings reporting season continued to roll on with results Wednesday including CVS Health
CVS,
-2.26%,
Humana
HUM,
+1.09%
and Carlyle Group
CG,
-3.05%
before the opening bell, followed after the close by PayPal
PYPL,
-11.33%,
Shopify
SHOP,
-5.05%
and Qualcomm
QCOM,
-9.25%.

Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, said “the market remains sensitive as the final throes of earnings season rumble on, but 82% of S&P 500 companies that have reported results so far have surprised to the upside, offering a bit of a sentiment buffer.”

In U.S. economic data, private-sector employment rose by 324,000 in July, payroll processor ADP said, in a sign that businesses continue to hire in response to steady economic growth. Economists polled by the Wall Street Journal had forecast a gain of 175,000. In its revised figures for June, ADP said 455,000 new jobs were created instead of the initially reported 497,000.

“The ADP report is favorable for the economy’s prospects of securing a soft landing, meaning inflation returning to the Fed’s target without a large downturn,” according to Bill Adams, Chief Economist for Comerica Bank.

“To do that, the economy needs to cool enough that labor demand and supply come better into alignment, but not so much that job losses at employers that are cutting back overwhelm the effect of hiring at employers that are still expanding.”

Companies in focus

• Advanced Micro Devices Inc.
  AMD,
  +4.13%
  ended 7% lower on Wednesday after the chipmaker beat on earnings, and a forecast a bounce back in its PC chip business.

• Starbucks Corp.
  SBUX,
  +0.31%
  rose 0.9% even though the coffee chain reported third-quarter same-store sales that missed expectations, despite a big rebound in China.

• Merck & Co.
  MRK,
  -0.44%
  stock climbed 0.4% after the pharmaceutical company swung to a second-quarter loss as it booked a charge related to its $10.8 billion acquisition of Prometheus Biosciences Inc.

• Kraft Heinz Co.
  KHC,
  -1.80%
  gained 1.2% after the parent of Heinz ketchup, Jell-O and Cheez Whiz consumer foods reported second-quarter sales that came up short of expectations, as an 11% jump in pricing wasn’t enough to offset a 7% drop in volume and mix and market share pressure. 

• Yum Brands Inc. stock 
  YUM,
  +0.26%
  was off 1% Wednesday, after the parent of Taco Bell, Pizza Hut and KFC fast-food restaurants beat profit estimates for the second quarter but posted weaker-than-expected revenue. 

• CVS Health Corp. 
  CVS,
  -2.26%
  went up 3.3% after the drug store chain and health care services company reported second-quarter profit and revenue that beat expectations, amid strength in the health care benefits business. 

Jamie Chisholm contributed