Market comment: Market turmoil due to several factors
Financial markets experienced increased market volatility after disappointing macro-economic data, higher policy rates in Japan and increased geo-political tensions in the Middle East. This change in sentiment made equity markets drop and investors flee to safe havens such as government bonds and gold. Despite increased recession risks, we stick to our base case of a world economy slowly converging towards a more trend-like pace of growth. Therefore, we retain our modest overweight in equities and bonds.
Several reasons for higher volatility
Equity markets have performed very well year-to-date and have reached new all-time highs half July. Since then, equity markets dropped even though the earnings season has beaten expectations. Last week, the sell-off on markets intensified after the Bank of Japan increased rates for the second time this year, while signalling a third could follow. This led to a stronger Japanese yen versus the US dollar and to unwinding of carry trades. A carry trade is a strategy that involves borrowing at a low rate (for example in yen) and investing in a higher rate environment, such as in US stocks. Unwinding of carry trades has led to forced selling.
Last week also saw disappointing US macro-economic data over July, which led to increased recession fears. Producer confidence, as measured by ISM Manufacturing index, was weaker than expected and in contraction territory. However, another equivalent US producer confidence index (Manufacturing PMI) improved, showing somewhat conflicting signals. On Friday, the jobs report missed expectations and showed an unexpected increase in unemployment. This added to recession fears and to markets pricing in more rate cuts this year from the US Federal Reserve (Fed).
Finally, last week geo-political tensions in the Middle East increased after the killing of a Hamas leader in Iran and a Hezbollah commander in Beirut. Iran said it (and its proxies) would retaliate to Israel.
All in all, these factors resulted in increased volatility on financial markets. Equities worldwide and cryptocurrencies sold-off, yields dropped, gold prices increased and the US yield curve became flat again.
Recession risks have risen, but base case still intact
We acknowledge that recession risks for the US economy have increased, but we believe the rise in unemployment rate is exaggerated by some factors and we expect it to ease off. On top, the US economy has a lot of strong fundamental supports and we believe the Fed will start cutting rates from September. As such, we stick to our view that the US economy will moderate to below trend growth, and that growth is picking up in the eurozone and China. We expect the world economy to converge toward trend growth in the second half of 2024.
What could investors do?
It is always important for investors to remain calm when market volatility increases. We hold on to our modest overweight in equities and bonds, while we also acknowledged that market volatility could increase in the coming months. For now, the equity sell-off and change in investors’ sentiment are no reason to make changes to our portfolio.
Equity markets have had a very good run so far this year. We see the correction as healthy and feel that recession calls are overblown. We stick to our base case with the world economy converging towards trend growth and with central banks to continue cutting rates. This justifies not only an overweight in equities, but also an overweight in high quality bonds and a long duration.