Market Update: Goodbye July, Hello Market Volatility
Following a relatively quiet June and a big stock rally during the first half of July, the last two weeks brought with them a return of normal stock market volatility. Sparking the most recent wave of selling, the Bureau of Labor Statistics’ August payrolls report missed expectations, with the economy only adding 114,000 jobs versus the consensus estimate of 175,000 (Reuters). This spooked an already on-edge market following a weak outlook for manufacturing jobs from the Institute of Supply Chain Management and initial jobless claims reaching their highest level since last August.
Taken together, the news was negative, although not nearly so bad that it would indicate an economic retracement around the corner. Investors, however, were watching the data come in on the heels of last Wednesday’s Federal Reserve meeting, which gave no confirmation that rate cuts were coming in September. They took the combination of the meeting and data as a sign the Fed waited too long to cut rates and that their inaction is putting the global economy in danger. Stocks sold off, led lower by economically sensitive small caps, artificial intelligence (AI) darlings, and Japan.
How The Bank of Japan Intensified the Selloff
As sentiment soured in the US and Europe last week, the Bank of Japan (BoJ) decided to hike its benchmark interest rate from 0%–0.10% to 0.25%. Yes, Japan’s benchmark interest rate target is a full five percentage points lower than our Federal Funds Rate here in the US! They cited sluggish progress in their ongoing battle with inflation this year as the rationale for the rate hike.
This surprise hike caused Japan’s Nikkei 225 stock index to drop 23.2% between last Tuesday and Monday’s close (Yahoo Finance). While not anticipating this exact event to be the cause, we identified Japanese stocks earlier this year as not offering attractive potential risk/reward ratios and cut our exposure in April to less than 20% relative to our global stock benchmark, the MSCI All-Country World Index. While the BoJ’s actions are causing ripple effects across global markets, our actions in April helped protect investors from the epicenter of this recent selling.
As far as ripple effects are concerned, there are many investors that engage in “carry trading,” which involves attaining loans in low-interest currencies such as the Japanese yen and investing the proceeds in high-yielding currencies such as the US or Australian dollar. It’s a viable long-term strategy, but when borrowing rates (yen) increase and investing rates decrease, it generates losses. The fact many investors carry trade using leverage exacerbates these losses and causes margin calls. Margin calls then cause forced liquidations of other assets, such as stocks, driving selloffs in other asset classes. In my opinion, what we’re seeing is a classic deleveraging and carry trade “blow up.” Following a short period of deleveraging, markets usually normalize within a couple of weeks.
Bond Investments – Good News in a Tough Market
In our July commentary we noted a tactical shift in our bond portfolios. Specifically, we had compelling technical, fundamental, and economic evidence that a new rate cutting cycle was on the horizon. With this in mind, we decided to lock in attractive long-term interest rates, swapping our floating rate bond positions (ticker FLOT) for longer-term bonds (ticker SPTL) at the end of June. This represented reallocating 20% of any given bond portfolio. Since June 20, FLOT (what we sold) is up 0.46%, while SPTL (what we bought) is up 5.30%, which has served to help reduce overall drawdowns in the latest market correction.
While there is always potential for volatility along the way, we have high confidence that long-term bonds and fixed income investments in general will have strong performance over at least the next couple of years as the Federal Reserve cuts interest rates.
What Next? Is This “The Big One”?
Sentiment has soured in the last week, and the fear of a global recession is on the rise. Based on our four proprietary systems designed to identify major economic slowdowns, recessionary storm clouds are currently absent. Therefore, we view this selloff as a simple deleveraging of carry trades and other overcrowded investments, such as AI stocks. And once the deleveraging is complete, we should be back to positive stock performance.
In the meantime, the next major central bank event will be the Jackson Hole Economic Policy Symposium from August 22–24. Jerome Powell will give his keynote speech, which is widely anticipated to include definitive language regarding the timing and magnitude of rate cuts through the end of this year. Currently, futures markets are implying at least a full 1.00% of cuts through year-end, while the Fed’s latest projections only hinted at 0.50%–0.75% (CME Group).
As always, we graciously appreciate the opportunity to be your partner on your wealth-building journey and look forward to continuing to serve you through all market environments.
Goodbye July, Hello Market Volatility
Market Update: Goodbye July, Hello Market Volatility
Following a relatively quiet June and a big stock rally during the first half of July, the last two weeks brought with them a return of normal stock market volatility. Sparking the most recent wave of selling, the Bureau of Labor Statistics’ August payrolls report missed expectations, with the economy only adding 114,000 jobs versus the consensus estimate of 175,000 (Reuters). This spooked an already on-edge market following a weak outlook for manufacturing jobs from the Institute of Supply Chain Management and initial jobless claims reaching their highest level since last August.
Taken together, the news was negative, although not nearly so bad that it would indicate an economic retracement around the corner. Investors, however, were watching the data come in on the heels of last Wednesday’s Federal Reserve meeting, which gave no confirmation that rate cuts were coming in September. They took the combination of the meeting and data as a sign the Fed waited too long to cut rates and that their inaction is putting the global economy in danger. Stocks sold off, led lower by economically sensitive small caps, artificial intelligence (AI) darlings, and Japan.
How The Bank of Japan Intensified the Selloff
As sentiment soured in the US and Europe last week, the Bank of Japan (BoJ) decided to hike its benchmark interest rate from 0%–0.10% to 0.25%. Yes, Japan’s benchmark interest rate target is a full five percentage points lower than our Federal Funds Rate here in the US! They cited sluggish progress in their ongoing battle with inflation this year as the rationale for the rate hike.
This surprise hike caused Japan’s Nikkei 225 stock index to drop 23.2% between last Tuesday and Monday’s close (Yahoo Finance). While not anticipating this exact event to be the cause, we identified Japanese stocks earlier this year as not offering attractive potential risk/reward ratios and cut our exposure in April to less than 20% relative to our global stock benchmark, the MSCI All-Country World Index. While the BoJ’s actions are causing ripple effects across global markets, our actions in April helped protect investors from the epicenter of this recent selling.
As far as ripple effects are concerned, there are many investors that engage in “carry trading,” which involves attaining loans in low-interest currencies such as the Japanese yen and investing the proceeds in high-yielding currencies such as the US or Australian dollar. It’s a viable long-term strategy, but when borrowing rates (yen) increase and investing rates decrease, it generates losses. The fact many investors carry trade using leverage exacerbates these losses and causes margin calls. Margin calls then cause forced liquidations of other assets, such as stocks, driving selloffs in other asset classes. In my opinion, what we’re seeing is a classic deleveraging and carry trade “blow up.” Following a short period of deleveraging, markets usually normalize within a couple of weeks.
Bond Investments – Good News in a Tough Market
In our July commentary we noted a tactical shift in our bond portfolios. Specifically, we had compelling technical, fundamental, and economic evidence that a new rate cutting cycle was on the horizon. With this in mind, we decided to lock in attractive long-term interest rates, swapping our floating rate bond positions (ticker FLOT) for longer-term bonds (ticker SPTL) at the end of June. This represented reallocating 20% of any given bond portfolio. Since June 20, FLOT (what we sold) is up 0.46%, while SPTL (what we bought) is up 5.30%, which has served to help reduce overall drawdowns in the latest market correction.
While there is always potential for volatility along the way, we have high confidence that long-term bonds and fixed income investments in general will have strong performance over at least the next couple of years as the Federal Reserve cuts interest rates.
What Next? Is This “The Big One”?
Sentiment has soured in the last week, and the fear of a global recession is on the rise. Based on our four proprietary systems designed to identify major economic slowdowns, recessionary storm clouds are currently absent. Therefore, we view this selloff as a simple deleveraging of carry trades and other overcrowded investments, such as AI stocks. And once the deleveraging is complete, we should be back to positive stock performance.
In the meantime, the next major central bank event will be the Jackson Hole Economic Policy Symposium from August 22–24. Jerome Powell will give his keynote speech, which is widely anticipated to include definitive language regarding the timing and magnitude of rate cuts through the end of this year. Currently, futures markets are implying at least a full 1.00% of cuts through year-end, while the Fed’s latest projections only hinted at 0.50%–0.75% (CME Group).
As always, we graciously appreciate the opportunity to be your partner on your wealth-building journey and look forward to continuing to serve you through all market environments.
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