In early August, fears over an imminent recession in the US sent stock markets tumbling. The Japanese Nikkei 225 Index shed an eye-watering 12% in just one day of trading – its worst one-day performance since Black Monday in 1987. It also marked its most significant three-day session lost since 2011. The equity markets then reversed their direction of travel and some incredible gains were recorded over the following few days.
Historically, August has been often an unpredictable month. Iraq invaded Kuwait in 1997 which was not without its repercussions for the markets, Asia was plunged into financial crisis in 1988, and Russia defaulted on its debt in 2010, triggering the collapse of highly-leveraged hedge fund LTCM. Then there was the European debt crisis in 2011, followed by the US debt downgrade by Standard & Poor. China devalued the yuan in 2016, and this year we saw the Japanese carry trade collapse.
These events constitute good grounds for global institutions and investors to reduce their exposure to risk assets such as equities in favour of cash and short-dated bonds. By way of an example, Norway’s US $.1.7 trillion sovereign wealth fund has pared back on some of its core positions, such as Meta Platforms, Novo Nordisk and ASML. This makes some sense after such a strong run in performance.
However, time and again, this has proved to be the wrong course of action over the long term. As US investor and philanthropist Peter Lynch once put it, “... far more money has been lost by investors trying to anticipate corrections than [has been] lost in the corrections themselves”.
The whole history of stock market investing is quite simple: long-term gains can be excellent. But to achieve them, you have to withstand endless volatility and market mania. You have to be able to tune out never-ending geopolitical events, political uncertainty, financial crises and the odd pandemic. And you have to be immune to the fear and panic syndrome that clients and investors invariably suffer every time a crisis rears its head.
Every global crisis brings with it valuable lessons. And every one of these crises has ended up rewarding investors over the longer term. Never let a good crisis go to waste, as Churchill reputedly said.
Only once has the VIX Index (fear gauge index) closed below 30, then surged above 60 (intraday) the following day, before closing below 30 again the day after that. And that was this August.
Furthermore, the last three instances when a 10-point decline in the VIX in a single day has been recorded has signalled a buying opportunity. These were the flash crash in May 2010, the US debt downgrade in August 2011 and the Covid market crisis in March 2020. In each case, the S&P 500 Index then rallied by an average of 25% over the following 12 months.
Indeed, since 1928, a low has been registered in August, and even a market bottom in the first week of the month. Each of these events has constituted a clear signal to buy on the dip.
Over the past week, the markets have recovered and the S&P 500 Index is now up over 6.5% from its 5 August low. Even the tech-heavy Nasdaq Index is up by 8%. Two themes have driven this positive sentiment over the past few days: inflation in the US continues to moderate, and economic data continues to show some resilience (both retail sales and jobless claims have come in better than forecast). The US economy may be cooling, but it is certainly not on the edge of any kind of sharp downturn or recession. The global economy therefore looks set to enjoy a soft landing.
In our view, a moderating inflation rate combined with a cooling but positive economic growth rate are still grounds for the US Federal Reserve Bank to cut interest rates as early as September 2024. A clear indication of what Fed chair Jerome Powell might do next could come as early as next week when the leading global central bankers meet for their annual Jackson Hole Symposium.
As for the number of cuts, the consensus view is four to five by the year end along a trajectory that will see rates settle at 2% sometime next year. But all of this will depend on the next few months’ inflation and unemployment data.
In the UK, headline inflation ticked up to 2.2% in July, up from 2% the previous month. However, growth in services prices – a focus for UK policymakers – slowed more than was forecast, prompting financial markets to price in a higher likelihood of interest rate cuts later this year.
The UK economy remained strong in the three months to June: GDP was up 0.6% sequentially, following a solid rebound on the first quarter after last year’s recession. As for the stock market, the UK is back in vogue.
Labour’s agenda is to boost growth and catapult the UK into first place on the growth tables for the leading G7 economies. If it succeeds, the result will be a natural increase in tax revenues and no need to hike tax rates or impose new taxes (it made a manifesto pledge not to do so).
In fact, Chancellor Rachel Reeves has said that she wants to restore stability as a condition for making UK a more attractive place for domestic and overseas investors. The previous government, she believes, lost its direction on this issue after years of chaos at Number 10, confusing the electorate and putting off investors.
Curiously, global investors now appear to be more bullish in relation to UK stocks, than their European brethren. In recent years, UK equities have become cheap and undervalued compared with their international counterparts. But with the economic and inflationary backdrop changing and a new government installed, institutional investors and private clients are increasingly drawn to the UK stock market.
Japan’s stock market has rebounded strongly after the turmoil earlier this month. A weaker yen relative to the US dollar provided a tailwind for Japanese exporters, while the latest data suggests the US has soothed concerns over a possible recession. Japan’s latest GDP figures also showed better-than-expected growth.
Outside of traditional equities and bond markets, the rise in the price of gold bullion has been impressive. The yellow metal has risen for the first time above US $2,500 per troy ounce. Fuelled by lower US Treasury bond yields and the dollar, gold is up 20% year-to-date, setting the stage for its strongest annual performance since 2020 when it gained 25.1%. Central banks around the world have been significant buyers and holders of gold, accounting for around a fifth of all the gold that has been mined throughout history. Gold is an important component of central bank reserves because of its safety, liquidity and return characteristics.
Meanwhile, US Secretary of State Anthony Blinken has arrived in Israel in a last-minute effort for a ceasefire and a hostage release deal in Gaza. Concerns about Iran retaliating over the assassination of Hamas leader Ismail Haniyeh in July have in turn sparked concerns that Tehran might attack Israel, which would result in all-out war in the Middle East. In Europe, Ukrainian troops have been strengthening positions in captured territory in Russia, while Vladimir Putin is showing no sign of regret over his invasion of Ukraine, still maintaining that there can be only one possible outcome: a Russian victory.
A lull over the summer is typical. While there are a number of issues which threaten to destabilise the bull market, history tells us that if the US Federal Reserve Bank starts to cut interest rates and the economy holds up (if it enjoys a soft landing), then the markets do well over the remainder of the year, and into 2025.
If we see further weakness in the markets in September and October, or around the time of the US presidential election, we will use these periods of volatility and pullbacks as investment opportunities – particularly if inflation trends and economic growth start to cool but remain positive.
