Perspectives on Recent Volatility
August 06, 2024

Volatility in Markets

Volatility in Markets

A bout of volatility hit the market over the past week, after the S&P 500 reached an all-time high in mid-July. For much of this year, the economy appeared on track for a “soft landing” in which the Federal Reserve (Fed) cools inflation through rate hikes without causing a recession. This notion has been supported by recent economic data such as the benign CPI report from June and second quarter GDP, which showed the economy grew by 2.8%, beating expectations and supported by robust consumer spending.

However, the disappointing July employment data released last week has shifted the narrative, causing investors to question the health of the labor market and whether the economy can maintain this growth going forward. The unemployment rate jumped to 4.3% (the Fed’s target is 4%), and employers added just 114,000 jobs in July, much lower than the expected 175,000. Weekly jobless claims saw an increase to the highest level in a year, although they tend to be volatile in the summer. When combined with lackluster earnings reports from some of the US mega cap technology growth stocks (Magnificent 7) and news that famed investor Warren Buffett sold more than half his stake in Apple, US stocks came under pressure. The selling spread to global markets and was exacerbated by a rapid rise in the Japanese yen which triggered an unwinding of the yen carry trade, where investors borrow yen at low rates to invest in higher-yielding assets.

We address each of these concerns below along with some thoughts on the Fed, corporate earnings, and our portfolio positioning.

Labor Market

Though the unemployment rate is showing cracks, there are exogenous factors affecting the jobs data. The recent uptick in immigration to the United States has largely increased the number of people seeking employment. If immigration had occurred at a normalized rate following the pandemic, the unemployment rate would be below the Federal Reserve’s long-term target. Furthermore, there appears to have been weather-related issues in the July jobs report from Hurricane Beryl. It is important to note that monthly jobs data is frequently revised, and we won’t know for several months whether July is the start of a weakening of the overall trend. Additionally, permanent layoffs have remained stable, and job cut announcements continue to fluctuate at historically low levels.

Mega Cap Tech Selling

The selloff was triggered by a reality check for U.S. mega-cap technology growth stocks when earnings and forward guidance fell short of expectations. Investors began to question whether the aggressive spending on A.I. infrastructure would yield sufficient returns. While the repricing of these stocks may continue, the impact on the global economy should be limited. This could spark a rotation into other sectors and companies that are more attractively valued and poised for growth.

Yen Carry Trade Unwind

The Bank of Japan (BOJ) raised interest rates by 0.15% on July 31, more than anticipated and sent the signal of more hikes to come. The BOJ is ending a long period of rates between 0% and -0.1%. The Japanese yen strengthened after this latest hike and has appreciated more than 10% vs the US dollar in just the past few weeks. This prompted many investors to seek liquidity by selling securities to unwind their carry trades and repay their yen loans. The process of this unwind and impact on global markets may continue for several days but is expected to subside as the yen stabilizes. 

Federal Reserve

Though the Fed is typically agnostic to equity and bond market conditions – the current chairman, Jay Powell, has shown tendency to be influenced by the state of liquid markets. With this recent volatility, the market now expects the Fed will be aggressive in cutting rates at their upcoming September meeting, up to 0.50%. A reduction in interest rates, along with the expectation of a supportive Fed, should help overall sentiment and encourage economic growth.

Corporate Earnings

Despite some disappointing reports from the Magnificent 7, overall earnings per share for the S&P 500 are up 11.2% year over year, with 75% of companies reporting through Q2. There have been concerns that earnings growth has been overly concentrated in just a few companies, but recent earnings have shown a significant broadening. For example, small cap US companies have shown earnings growth of 19.4% year-on-year.

Volatility in Markets

Portfolio Positioning

Our investment philosophy on the stock side remains consistent – we build portfolios with downside protection in mind. We focus on high-quality, high-profitability companies, with strong balance sheets that are not as dependent on interest rates for growth. Because of the stability these types of companies provide, our equity strategies have experienced less downside than the broad market in past corrections and early signs indicate that our current equity holdings are faring in a similar manner. Protecting investments on the downside provides a higher base from which to grow when the market rebounds.

Importantly, for the first time in several years, traditional bonds are providing a meaningful inverse correlation benefit to equities, meaning they tend to appreciate as stock prices drop. This has also helped limit downside exposure to portfolios during this selloff.
We remain constructive on the economy and markets in general – GDP growth is healthy, inflation is trending in a positive direction, and many sectors and industries are projecting significant revenue and earnings growth ahead. While this type of volatility can be unsettling, it often represents significant opportunities which we constantly strive to uncover for our clients.

We invite you to reach out with any questions or concerns – we’re always happy to assist.

Have a Question?

Thank you!
Oops!