Mood Swings
Summary
- The Federal Reserve hinted at a potential rate cut, while the Bank of Japan unexpectedly raised rates, triggering a dramatic sell-off in Japanese stocks and reverberating through global markets due to the ‘carry trade.’
- U.S. jobless claims exceeded estimates, and the unemployment rate ticked higher, sparking recession fears according to the ‘Sahm Rule’, although some experts argue this time may be different.
- Despite the market turbulence, global stocks and bonds saw gains in August, supported by lower-than-expected inflation and growing expectations of an interest rate cut by the Federal Reserve.
- September has historically been a weak month for market performance, with four consecutive down years, and this year is off to another poor start, potentially marking five straight years of declines. While the temptation to react to short-term market trends is strong, it's crucial to zoom out, focus on long-term fundamentals, and avoid getting caught up in the noise of market headlines.
Carry Trade
At the end of July, the Federal Reserve confirmed it was inching toward a rate cut, while on the same day, the Bank of Japan made a surprising move by raising interest rates from 0.0% to 0.25% and scaling back its bond purchases.
This came as a shock to the Japanese stock market; it fell a whopping -19.5% in just three trading days, the fastest drop of this magnitude since the 1987 crash. The carnage, however, wasn’t just contained to Japan. Its tentacles attached to other markets due to a little thing known as ‘the carry trade.’
Source: Bloomberg. Nikkei 225 Index. Data from 7/31/2024 to 8/30/2024.
An aging population and high debt levels have pushed Japan to experiment with a small—and often negative—interest rate. In response, people could borrow at rock bottom rates and invested these borrowed funds into a number of different assets with higher yields or higher expected returns. This is known as a carry trade.
Due to the shock of higher interest rates and a strengthening of the yen, levered market participants unwound their trades, seemingly all at once, and this motivated selling in a multitude of separate asset classes.
This was just the start. Next, in the U.S., both initial jobless claims and continuing unemployment claims came in above estimates, which increased worries surrounding the shaky employment picture. Adding to the fear, the unemployment rate ticked higher in July, increasing from 4.1% to 4.3%, according to the Bureau of Labor Statistics. While low compared to historical standards, it represents a trend in the wrong direction and triggered what’s known as the ‘Sahm Rule.’
Historically, whenever this rule has been triggered, it has signaled that the economy is already in a recession. But is this time different? The rule's creator quickly addressed the current situation, stating that she doesn't believe the U.S. is in a recession this time because the rise in the unemployment rate is not due to weakening demand for workers but rather to an increase in the supply of workers.1
To top off the chaos, Warren Buffett’s Berkshire Hathaway announced it had sold a significant portion of its long-held Apple position. Since Apple is the largest stock by weight in the S&P 500 Index, the market interpreted this move as both a troubling signal about the company's future prospects and the potential to weigh down the S&P 500 Index moving forward.
Given all of the crummy news in such a short window of time, it’s no wonder that volatility spiked. Adding insult to injury the S&P 500 Index fell -8.5% from its all-time high. But here's the twist: despite all the seemingly bad news, both global stocks and bonds edged higher in August.
Look no further…
Source: Morningstar Direct. Nova R Wealth. June, July, and August are monthly returns. See important disclosures at the end of this material.
The rebound in markets occurred mid-month after the headline inflation index came in slightly below estimates (2.9% year-over-year vs. 3.0% estimate). On a month-over-month basis, the figure only rose 0.2%, according to the Bureau of Labor Statistics. Chairman of the Federal Reserve, Jerome Powell, acknowledged this progress in a speech at Jackson Hole, stating “The time has come for policy to adjust.” Traders are now pricing in a 100% probability of a 0.25% interest rate cut and the potential for a 0.50% rate cut if data weakens further on the inflation or labor market front.
Seasonality
F. Scott Fitzgerald writes in his famous book The Great Gatsby, “Life starts all over again when it gets crisp in the fall.” In recent years, this quote certainly rings true as September rolls around—a month infamous for poor returns. More recently, September has been especially weak, with four consecutive down years.
Source: Bespoke Investment Group.
As we write this, September is off to another poor start, potentially making it five consecutive down years in a row. While it can be tempting to market time an anomaly such as this, it’s important to zoom out, resist the siren song of mood swings in markets irrespective of estimates of fundamental value, and stay clear of market headline hyperbole that is sure to come throughout the rest of the year.
(1) Sahm, Claudia. "My Recession Rule Was Meant to Be Broken." Bloomberg, 7 Aug. 2024, https://www.bloomberg.com/opinion/articles/2024-08-07/the-sahm-rule-is-warning-of-recession-but-claudia-sahm-isn-t-sold.
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