Despite media saturation of the Olympics over the past two weeks, it was hard to miss news of the recent volatility in global equity and bond markets. If we think back to roughly two weeks ago, market consensus would have mostly leant in the direction expressed in our recent CIO monthly titled Staying the course through H2, where our central thesis remains ‘on track’ and we expect lower growth, moderating inflation, and a modest interest rate easing cycle for the next six to 12 months. However, like prior events we have experienced (including those in recent memory, such as conflicts in Russia/Ukraine and Israel/Gaza, as well as the collapse of Silicon Valley Bank), no one can predict these movements of extreme market volatility.
Whilst history can provide a guide to the future, no two events are ever the same, nor are the impacts across different asset classes.
The most recent bout of volatility has been the most extreme since the COVID-19 outbreak in March 2020. What happened is something that may have been broadly identified as a risk, but the impact and timing, along with the magnitude of the market movements, are events that couldn’t have been predicted. Further, whilst history can provide a guide to the future, no two events are ever the same, nor are the impacts across different asset classes.
Initially, markets were unsettled by negative results from ‘magnificent seven stocks’, followed by softer- than-expected US July non-farm payrolls. This led investors to consider that the risk of recession was greater than previously expected. Added to this was the unwinding of the crowded Japanese yen carry trade. This occurred as the Bank of Japan raised interest rates for only the second time in the past 17 years and signalled an intention to support the yen. This led to further technical selling in equity markets (particularly in Japan and the US), as the cost of borrowing in yen to invest in investments denominated in other currencies (otherwise known as the ‘Yen carry trade’) rose.
Six business days after the initial market dislocation markets seemed to have calmed. This happened after better-than-expected US weekly jobless claims data was released, suggesting that a recession may not eventuate and the US Federal Reserve may not have to cut rates aggressively, given growth remains robust. So, the market volatility had potentially ended not long after it began. The level of extreme volatility has subsided for now, and for long-term investors, staying the course remains important, not just through the rest of 2024 but well beyond this year. Indeed, signs of slowing US data (as we expected), that will from time to time create market angst, have the potential to foster more frequent bouts of volatility over coming months than may have been the case over H1 2024.
The level of extreme volatility has subsided for now, but for long- term investors, staying the course remains important.
In the short term, we still expect modest rate cuts, so investors should invest as opportunities are presented at both the asset class level and within asset classes. Over longer periods, investors should avoid making investment decisions driven by panic and emotion as a reaction to market movements, and should remain focused on their portfolio’s strategic asset allocation.
Often, investment decisions based on panic and emotion lead to selling at the bottom of the market, and often these decisions result in the investor failing to reinvest in time to participate in any subsequent market rebound. It can be seen from the chart below that the best and worst trading days occur very close together. The close proximity of the best and worst trading days means that it is difficult to time the market—that means it is difficult to sell at the bottom of the market and buy back into the market before it rallies.
Events over the past couple of weeks remind us of one of the most important investment principles – diversification, particularly across and within asset classes. As equities generally represent the largest allocation (and risk) within a diversified portfolio, this means that investors should ensure there is an adequate allocation to investments that are less correlated to equities. If you have any questions, please contact your LGT Crestone adviser.
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