05 August 2024
If you are covering the volatility in financial markets, please find below a comment from Lindsay James, investment strategist at Quilter Investors:
“The market rout in Japan overnight, which saw the Nikkei 225 index fall more than 12 per cent, looks to be a precursor to more volatility in US and European markets this week. Concerns have risen that the US economy is seeing a rising risk of recession at the same time as the Bank of Japan has begun to raise rates, effectively stymying the popular carry trade which saw investors borrowing cheaply in yen to invest overseas.
“Ultimately this period of outsized volatility against what remains a reasonably solid economic backdrop should present a buying opportunity for long-term investors. Current market moves in the US and Europe are well within the bounds of normal market volatility, particularly given that high concentration in US markets saw the Magnificent Seven stocks dominating US equity market performance for much of the first half of the year
“Despite a generally positive second quarter earnings season, with more than three-quarters of companies reporting better-than-expected profitability, high-profile disappointments from companies like Microsoft and Amazon have caused significant drops in the index. The MSCI USA Equal Weighted Index, which weights each stock equally, remained flat in sterling terms for the month up to 2nd August. In contrast, the MSCI USA Index declined by 3.92% over the same period. This indicates that recent declines have been more concentrated among the Magnificent Seven stocks, as other companies, with more reasonable valuations and less ambitious earnings expectations, have been less affected.
“Economic data has also been taken badly at a time when sentiment has already been more sensitive to bad news. Data out last week showing weak employment payrolls in the US and a rise in unemployment to 4.3% in July challenged investors’ expectations of soft landing, which had become a high conviction view across the market.
“With the Federal Reserve also holding off on a first rate cut, but signalling that inflation looked to be on track to allow for an initial move in September, investors were concerned that cuts would come too late, with the Bank of England and ECB having already made the first move down. This seems a stretch given the fundamental health of the US economy. Growth in the second quarter was a respectable 2.8% on an annualised basis, with labour productivity growing 2.3%, which ultimately raises the potential for US growth in years to come but with welcome downward pressure on prices.
“That said, there is a clear slowing in the US economy as we move into the second half of the year, indicated by the raft of companies reporting weaker consumer trends particularly in lower income groups, as high interest rates continue to act as a headwind. This does, however, fall well short of a recession, with the GDPNow indicator published by the Atlanta Fed forecasting 2.5% growth in the third quarter, as a seasonally adjusted annual rate.
“Whilst recent data has done little to calm investors nerves, we are at point in the economic cycle where central banks have maximum firepower to stimulate growth and are entering a phase where we would expect this to be gradually deployed to good effect.
“Inflation trends are improving, with a slower economy likely to support that, whilst the phenomenon of the highly valued Magnificent Seven stocks is now being rightly tested and ultimately likely to lead to a broadening of market returns. As we move towards a first rate cut in the US at a time of geopolitical uncertainty and deep social division, volatility could well be persistent. However, for long-term investors, this can be a great time to take advantage of a better entry point with globally diversified, multi-asset portfolios well equipped for this backdrop.”
