A hot August for the financial markets
Investment Update - September 2024
August was a volatile month on the financial markets. Performance remains in positive territory, however, with global equities gaining 0.44%1 and European equities gaining 1.60%1, while their US counterparts returned just 0.20%1. It should be noted that the US dollar markets rose by almost 2.40%, although the euro’s almost-2% rise against the greenback was detrimental to European investors in US markets.
1Performance calculated in euros
While figures were positive at the end of the month, the start was more turbulent. On 2 August, US employment data showed a rise in the unemployment rate from 4.1% to 4.3%. Historical parallels suggest that this increase could signal the start of a recession, as whenever the three-month moving average of the national unemployment rate has risen by 0.50 percentage points or more relative to its low during the previous 12 months, a recession has begun. Economists refer to this as the “Sahm rule”, after its creator, former Fed economist Claudia Sahm.
Further analysis is needed, however, as in this instance the unemployment rate does not seem to be accompanied by a loss of jobs. Admittedly, the unemployment rate is rising, but that is not linked to a wave of layoffs. In this specific case, the increase is due more to an increase in the participation rate. Since the unemployment rate is simply the number of people officially looking for work relative to the labour force (in other words, it includes people in work and those actively looking for work), an increase in the number of active job-seekers can push up the unemployment rate. This is particularly the case for job-seekers who have recently arrived in the United States, who have not yet had time to find a job. This segment of the population has an unemployment rate of around 10%, which is pushing up the national average.
Meanwhile, to make matters worse, the Bank of Japan raised its key interest rates from 0.10% to 0.25%. The scale of this hike is admittedly not enormous, but the accompanying press release was considered very “hawkish” insofar as the Japanese monetary authority announced that it wanted to continue the normalisation of its monetary policy without too much delay. This led to a wave of panic on global markets, as Japan’s very low interest rates make it an inexpensive source of liquidity. Traditionally, investors borrow in Japanese yen to invest in foreign assets with good yields, particularly US assets. When interest rates are low on the Japanese yen, this is not a problem. However, this communication caused panic among those investors, who reacted quickly by selling their global holdings to convert their funds into yen. The yen rose by almost 10% in just a few days. Fortunately, the Bank of Japan quickly adapted its communication, announcing that it would not act while the markets remained turbulent.
Sovereign bonds naturally performed well during this volatility phase. In the United States, the 10-year yield stood at more than 4.20% at the end of July and ended August at 3.90%. The situation is similar in Germany, where the 10-year sovereign yield fell to 2.20% during the month.
Overall, this volatility phase has left its mark. Although the indices rebounded, investors turned towards more defensive sectors, such as Utilities, Real Estate and Healthcare, rather than Technology, whose valuation may be scaring off some investors, despite still-remarkable earnings growth.
Given this nervousness on the markets, it would seem preferable to adopt a neutral stance on equities pending the outcome of the US election in early November.
Historically, equities have not always performed well in this pre-election period, but have rallied in the last two months of the year. Agility will then be needed to take on risk again once the electoral uncertainty is resolved.
In sector terms, the decision to overweight Healthcare last month benefited from the sector rotation that has taken place since July. In addition, the theme of artificial intelligence is still present in portfolios through the Technology and Communications Services sectors.
Finally, continued caution would seem appropriate with regard to bonds following the recent sharp fall in rates. Bond market investors seem too hungry for future rate cuts... allowing significant risk of disappointment. Corporate debt, meanwhile, remains a key component in portfolio construction due to the carry it provides.
