Market Update: 6th August 2024

It is hard (for those not on the beach) to escape the news headlines covering the spike in global market volatility since the end of last week. Markets sold off globally yesterday – spurred by a sharp fall in Japanese equities on Monday morning – but are showing a recovery so far today.

The context here is very important. Equity markets have been particularly strong for the last nine months or so with AI-driven momentum and the expectation of central bank rate cuts. It is normal for some pressure to be released after strong periods as valuations become extended, but it is not easy to time or predict when this might happen. A market ‘correction’, defined as a drop of 10% or more from the most recent high, is quite normal and historically happens at least once every two years. Corrections can create opportunities as money flows around the system.

The Federal Reserve did not follow the Bank of England’s action last week, leaving the US interest rate unchanged. It seems that markets have, to date, overpriced the likelihood of a US rate cut, which is now felt to be overdue. This, together with a weak US jobs report on Friday (a lagging data point widely recognised to be unreliable) has brought fears of a recession in the US. Further, US tech stocks, the largest companies in the world by market cap, having been the winners so far this year have sold off heavily in recent weeks following tepid earnings reports and forward guidance.

Another reason for high volatility, and an explanation of the hit to Japanese markets yesterday, is the unwinding of the Yen ‘carry trade’ which describes investors (e.g. hedge funds) borrowing a cheap currency like the Yen, with Japan’s historic low (or negative) interest rate, to invest in other better-yielding currencies and assets, often magnified with leverage. The Bank of Japan last week raised the interest rate to 0.25% which caused the Yen to strengthen significantly, particularly as major currencies (USD, GBP, EUR) have priced in rate cuts. This has prompted the carry trade to unwind with investors closing their positions, likely covering margin calls and driving further downward pressure on risk assets.

Add to this the unfortunate escalating tension between Israel and Iran, the forthcoming US election, and other factors closer to home (not to mention riots, rate cuts or unexciting fiscal changes), and one can see why markets are a little choppy…

From the updates received from the investment managers so far this week, there have been no changes to the headline asset allocations. This is reassuring as it shows that the managers already feel well-positioned strategically. After all, fundamentals remain quite positive – global earnings growth is currently running at +11.5% (in £), the highest rate of growth since Q1 2022.

All asset classes have experienced heightened volatility since late last week. Defensive positions in cash and bonds will have done their job offsetting some of the losses from equities. Gold, which is typically a safe haven during choppy markets, has not been immune. We suspect this is due to selling pressure linked to the Yen carry trade unwinding, as explained above. We also expect to see less volatility in the portfolios than main equity indices due to the diversification of asset classes, low relative exposure to US big tech and a greater allocation to value and defensive companies through exposure to healthcare and insurance, for example. The managers are selectively looking at opportunities for buying or adding to discounted equities. Japan remains very compelling with improving corporate governance and focus on returns for shareholders, and exposure to the stronger Yen (in anticipation of a rate increase) has helped to dampen the move in valuations.

Trading today has been positive with Japan leading the way (the Nikkei 225 was up >10% overnight), showing how fast things can move. The Fed will be influential in their decision-making in the coming weeks and months. Indeed, the market is now expecting between four and five US rate cuts this year, including now fully pricing a 0.5% cut at, or before, the September 18th policy-making meeting. With heightened volatility, good news on dark days can create a lot of upside and reward those who ignore the noise.

As ever, do get in touch with us if you have any questions.

Go well,

Featherstone