MW Tech crash, Powell firing, bond turmoil - these are one firm's possible, if unlikely, gray swans

By Barbara Kollmeyer

Disappointments in generative AI monetization could lead to sell-off, strategists warn

Investors spend far too little time thinking about tail risks, that is, extreme events that are unlikely to happen, but would have a massive impact on growth and markets if they did.

Also known as gray swans, strategists at BNP Paribas, took a look at possible extreme scenarios investors should consider for 2025. Our call of the day focuses on how the three biggest might materialize and what investors should do.

U.S. technology stock crash. The Magnificent 7 tech stocks now make up 33% of the S&P 500 SPX by market cap, and with valuations already high, a return to the long-term price/earnings average alone would mean a 30% selloff, says a team of strategists led by Viktor Hjort.

"We think disappointments in GenAI monetization, efficiency improvements or a top line slowdown could trigger a selloff in U.S. equities. Our economics team's simulations suggest that a large equity correction, via the wealth effect, could spark a recession in the U.S.," says Hjort and his colleagues.

They base this on the 2001 U.S. recession, which hit in the middle of the March 2000 to Oct. 2002 stock selloff. They see a possible 40% equity market correction, followed by Fed action as yields fall and credit spreads widen. The recessionary knock on would come as consumer spending takes a hit, especially as BNP notes households currently hold nearly $60 trillion in equities.

One way for investors to protect themselves is buying Nasdaq-100 put spreads, that is an options strategy in which long and short positions on the same asset are taken out to protect from a selloff.

Fed Chair Jerome Powell gets fired. Let's say the Fed fails to deliver big rate cuts demanded by President Trump amid a large stock selloff or jobs slowdown and Powell is out. BNP offers one scenario putting a Trump appointee at the top of the central bank and all Democratic-appointed governors rapidly replaced.

Despite the Fed's "operational independence" over monetary policy, BNP points to a recent event. In early January, Trump fired a member of the National Labor Relations Board, which has similar protections to the Federal Reserve against removals. That official, Gwynne Wilcox, has said she might try to get the courts to reinstate her, which could set up a Supreme Court case to clarify whether Trump can fire officials in other agencies, such as the Fed, says BNP.

A trigger for this gray swan is tariff and immigration policies sparking higher inflation, forcing Fed rate hikes. That in turn could cause Trump to fret about the effect of lower stock prices and slowing growth on midterm elections for Republicans.

Where to hide? Damaged confidence over the Fed's independence would see a "pivot away from the U.S. dollar as the global reserve currency, and with that, large-scale U.S. asset sales," says BNP. The Japanese yen $(USDJPY.FOREX)$ could emerge as a haven. But appointing a more dovish Fed chair would cause a steepening of the yield curve - longer-term yields rising faster than shorter ones - on expectations of a less restrictive Fed.

A "Liz Truss moment" for U.S. Treasurys. The third gray swan harks back to 2022, when the former U.K. prime minister's short tenure caused surging U.K. government bond yields and financial markets chaos.

Possible investor doubts over the U.S.'s fiscal sustainability "could spark an unbounded rise in Treasury yields" similar to that Truss crisis and with even worse consequences, the strategists warn. Poor U.S. fiscal discipline and rising issuance would cause "bond vigilantes" to sell Treasurys, driving yields higher, possibly during the third quarter of this year. If inflation hasn't progressed toward the 2% target, the Fed may not step in to control yields, with the 10-year possibly breaching 5% and heading to 6%.

"Persistently higher Treasury yields could also hurt the valuation of risk assets, particularly U.S. equities (which currently enjoy historically elevated valuations) while also hurting growth as broad financial conditions tighten," said BNP. And of course, Treasury's "risk-free" status could get damaged.

The dollar could emerge stronger from such a crisis, but complicating matters for stocks are historically high stock valuations.

Gray swans, the strategists add, aren't always negative. Other gray swans they identify include OPEC+ unity dissolving, the eurozone economy growing faster than 2% this year, a bull market emerging in Brazil, a flow-driven boom in Chinese stocks, commercial real estate loans driving up bank non-performing loans, a default cycle in private debt, and an AI productivity boom in the U.S. economy.

The markets

Pre-CPI data, U.S. stock futures (ES00) (YM00) (NQ00) are slipping, as Treasury yields BX:TMUBMUSD10Y BX:TMUBMUSD02Y inch up. Gold (GC00) is stepping back from records.

   Key asset performance                                                Last       5d      1m      YTD     1y 
   S&P 500                                                              6068.5     0.51%   3.86%   3.18%   22.52% 
   Nasdaq Composite                                                     19,643.86  -0.05%  3.15%   1.72%   25.47% 
   10-year Treasury                                                     4.544      11.20   -11.30  -3.20   29.15 
   Gold                                                                 2918.6     1.16%   7.20%   10.58%  45.57% 
   Oil                                                                  73.12      2.78%   -7.63%  1.74%   -4.49% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

The buzz

Economists expect headline consumer prices, due at 8:30 a.m., to hold steady at a 2.9% rise for January, ticking up 0.3% monthly. Excluding food and energy, core CPI is seen rising an unchanged 3.2%.

Powell's second day of Capitol Hill testimony begins at 10 a.m. We'll also hear from Atlanta Fed Pres. Raphael Bostic and New York Fed Pres. John Williams.

Read: Forget CPI. This market indicator says inflation may stay above 2% for years.

Super Micro $(SMCI)$ cut its outlook, but an upbeat revenue outlook and shares are climbing.

Shares of Lyft $(LYFT)$ tumbled after a disappointing forecast for gross bookings. DoorDash's stock $(DASH)$ is rallying after a forecast for demand beat forecasts.

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Top tickers

These were the top-searched tickers on MarketWatch as of 6 a.m.:

   Ticker  Security name 
   TSLA    Tesla 
   NVDA    Nvidia 
   SMCI    Super Micro Computer 
   GME     GameStop 
   PLTR    Palantir Technologies 
   BABA    Alibaba 
   TSM     Taiwan Semiconductor Manufacturing 
   AAPL    Apple 
   AMZN    Amazon.com 
   AMD     Advanced Micro Devices 

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-Barbara Kollmeyer

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February 12, 2025 06:58 ET (11:58 GMT)

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