The stock market experienced its sharpest decline in two months after reaching record highs, as institutional investors began stepping back while retail traders remained aggressive buyers. The funding spread, a measure of institutional demand for leveraged stock positions through futures, options, and swaps, has dropped 50 basis points in recent weeks, hitting its lowest level since August 2024. A similar contraction in December 2021 preceded the 2022 bear market, raising concerns about a potential sentiment shift among professional investors.
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The downturn coincided with a worsening economic outlook, as consumer sentiment, housing data, and business activity weakened while long-term inflation expectations surged to their highest level since 1995. Interestingly, a different poll revealed that the sentiment was largely pushed lower by those identifying as democrats, while republicans tended towards a more positive outlook. This dichotomy could explain why money is flowing into ETFs but out of stocks.

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Trump also pushed his special advisor, Elon Musk, to move his DOGE group towards more cuts in federal spending via a post on Truth Social. The $500B cutting target has many federal employees, contractors, and NGOs completely spooked. And the ripple effects of these cuts and pauses are starting to show in Washington, D.C. and other cities.

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These factors reinforced uncertainty over the Federal Reserve's rate trajectory, leading to increased hedging activity. VIX call options volume exceeded 1 million contracts for the sixth time this year, with traders targeting strikes of 24 and 25 for March expiration, suggesting expectations of higher volatility around the Fed meeting on March 18th.

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Adding to the risk-off sentiment, a massive $2.7 trillion in options tied to equities and ETFs expired, increasing price swings. The S&P 500 dropped -1.7%, while the Nasdaq 100 tumbled -2.1% and the Russell 2000 - a measure of small cap stocks - fell -2.9%, indicating broad-based selling across major indices. Meanwhile, a late-session rally in vaccine stocks followed reports of a new coronavirus discovery in China, further fueling market jitters.

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Recession-resilient Stocks Outperformed Last Week

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The utilities sector led the S&P 500 this week with a 1.4% gain, followed by healthcare and energy, both up 1.1%. Consumer staples stocks also posted positive returns at 0.9%, while real estate stocks edged higher by 0.5%. On the downside, financials and materials sectors each declined -2%, while industrial stocks fell -2.1%. Information technology was slightly better, slipping -1.8%, whereas telecom saw a sharper drop of -3.7%. The biggest laggard of the week were consumer discretionary stocks, which tumbled -4.3%, marking the worst performance among all sectors.

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