News Flash - August 2024 - The return of market volatility
Volatility has made a strong comeback in the financial markets after months of relatively stable gains. On Friday, the S&P 500 lost nearly 2%, mainly due to a tough day for tech stocks. The rout continued this Monday, with the European index losing almost 3% and the US markets dropping by 3%. This was accompanied by panic in Japan, where the main index lost 12% on Monday.
In search of safety, investors flocked to sovereign bonds on both sides of the Atlantic. In the US, the bond market is now expecting significant rate cuts in the coming months, including a 50 basis point cut anticipated in September. In Europe, three more cuts are expected.
The main reason for these movements: economic fears.
In the US, recent economic figures have disappointed investors, particularly due to the recent rise in unemployment. The unemployment rate rose from 4.1% to 4.3% in July, which some investors interpret as a recessionary level.
According to the "Sahm Rule," developed by economist Claudia Sahm, a recession has already begun. The rule states that when the unemployment rate rises by 0.5 percentage points over three months compared to its minimum in the previous 12 months, a recession should start.
Historically, such a rise in unemployment has often resulted in a recession.
However, it's not that simple.
The recent increase in the unemployment rate is more related to a rise in the labor force participation rate than to job destruction. Additionally, the recent rise in immigration to the US inevitably increases the "frictional" unemployment rate, which corresponds to the natural job search duration.
Moreover, the latest report notes a significant increase in temporary layoffs, explaining nearly half of the rise in unemployment. Therefore, a return of these workers to employment in the coming weeks or months cannot be ruled out.
Finally, the increase in unemployment also includes people who did not work due to weather conditions, possibly because of Hurricane Beryl hitting the southern US.
With extreme concentration and markets at their peak, profit-taking in anticipation of potential economic deterioration seems plausible.
This movement has also been exacerbated, if not caused, by rising interest rates in Japan.
Investors have closed their "carry trades"—a strategy involving borrowing at low interest rates (in this case, in yen) to invest in higher-yielding assets. The repatriation of funds to Japan has thus driven down global stock prices and strengthened the Japanese yen.
From a fundamental perspective, there are still strengths in the US economy. The unemployment rate remains low overall, domestic demand is strong as evidenced by recent growth figures, and the Fed has significant room to cut rates. In fact, Jerome Powell, the Fed Chair, has not shown skepticism towards a rate cut; quite the opposite. With inflation heading towards 2% and interest rates currently between 5% and 5.25%, the Fed has the means to act.
It is also important to be cautious with economic data based on business and investor sentiment, as they have tended to be pessimistic in recent years. For example, the ISM manufacturing index, closely watched by markets for many years, came in below expectations last week. However, this indicator seems to have lost predictive power in the post-COVID period as it tends to underestimate growth. Therefore, it is essential to focus on concrete economic data, which is mostly at quite satisfactory levels.
Today, the soft landing that was so anticipated and largely achieved until now seems a bit less certain, but it remains the central scenario for most economists. Markets fear that the Fed is lagging behind the deterioration in employment, but such a judgment would be premature at this point.
Investors have closed their "carry trades"—a strategy involving borrowing at low interest rates (in this case, in yen) to invest in higher-yielding assets. The repatriation of funds to Japan has thus driven down global stock prices and strengthened the Japanese yen.
From a fundamental perspective, there are still strengths in the US economy. The unemployment rate remains low overall, domestic demand is strong as evidenced by recent growth figures, and the Fed has significant room to cut rates. In fact, Jerome Powell, the Fed Chair, has not shown skepticism towards a rate cut; quite the opposite. With inflation heading towards 2% and interest rates currently between 5% and 5.25%, the Fed has the means to act.
It is also important to be cautious with economic data based on business and investor sentiment, as they have tended to be pessimistic in recent years. For example, the ISM manufacturing index, closely watched by markets for many years, came in below expectations last week. However, this indicator seems to have lost predictive power in the post-COVID period as it tends to underestimate growth. Therefore, it is essential to focus on concrete economic data, which is mostly at quite satisfactory levels.
Recent periods of volatility have demonstrated that the investment solutions offered by Spuerkeess and its trusted partners, based on carefully diversified portfolios, offer a balanced ability to navigate through market uncertainties.
