Stock markets endured significant volatility in August amid fears of a US recession and the implications of an increasingly robust Japanese yen: Bank of Japan Governor Kazuo Ueda had adopted a somewhat hawkish stance on monetary policy, leading to speculators unwinding their yen carry trades. This pushed the yen upagainst the US dollar. A “carry trade” is an attempt to profit from the gap between the yields of a pair of assets – often, two currencies that attract different interest rates. In this case, borrowings in Japan's cheap currency, which are then invested in countries offering higher yields.
But as the month wore on, those fears abated somewhat, leaving the S&P 500 Index 1% higher. However, such a configuration may easily re-occur over the coming months, further shaking the markets.
In the meantime, however, supportive economic data and comforting words from US Federal Reserve Bank chair Jerome Powell at the Jackson Hole Symposium helped pare back some of those early stock market losses. As we know, sharp pullbacks in August and September are not unusual: indeed, the MSCI World Index is already down by 4% this month.
In actual fact, September is renowned for having yielded the lowest average monthly returns over the past 30 years. However, we think that there is more at play than just the usual seasonal gloom discouraging Wall Street traders and investors: next week, the Federal Reserve Bank will decide by how much it cuts interest rates.
Informing its choice will be the latest US labour market data that came in last Friday. The data actually shows an acceleration in job growth: 142,000 positions were added and the unemployment rate fell from 4.3% in July to 4.2%.
Admittedly, job growth over the previous two months has since been revised down by 89,000. This latest report will most likely determine whether interest rates are cut by 25 or 50 basis points. Following last Friday’s data release, the direction of the Fed Fund futures rate slightly increased the odds of a 50 basis point move, rather than the traditional 25 basis point cut.
Other significant data suggests that US manufacturing is now more sluggish than had been expected. That said, the ISM Manufacturing Index ticked up to 47.2 in August, up from 46.8 in July (any reading below 50 indicates a contraction). Elsewhere, geopolitics, trade and commodity moves all added to investors’ anxieties.
It's important to keep this recent volatility in perspective: most of the leading markets are still up for the year-to-date – the MSCI World Index has gained 7.39%, for example. As always, however, there are outliers. Brazil and China have fallen 15% and 4%, respectively.
Another distinguishing feature of this year so far has been the strength of sterling. This has reduced gains on overseas holdings for investors who have not taken out currency protection.
All asset classes, meanwhile, seem to have been outrun by gold in recent months, which has hit a new all-time high. There are three major factors behind this. Firstly, it is viewed by many as a hedge against long-term inflation. Secondly, it has recently been given a boost by India cutting its tax on imported gold – meaning a high probability of increased Indian demand for gold in the months ahead. Thirdly, there has been steady central bank buying because of its tendency to fare better when interest rates are lower; this cuts the returns on safer assets, such as cash and short-dated government bonds.
The UK economy fared better than most of the leading G7 economies over the first half of this year. Inflation has returned to the Bank of England's 2% target, but interest rates will most likely remain higher for longer: the UK economy is reliant on services, which can fuel wage pressures… which in turn can push inflation up.
We are now less than two months away from Labour’s first budget. It is thought that Chancellor Rachel Reeves will honour the party’s manifesto pledge not to raise taxes on “working people”. But other taxes have not been ruled out (pension, home, savings…). In the meantime, this uncertainty is creating significant debate among advisers and their clients.
In a number of respects, August was a positive month. Retail sales enjoyed a healthy boost: pleasant weather encouraged purchases of food items for picnics and barbecues, as well as new summer clothing. And according to Halifax, the largest UK mortgage lender, house prices reached a two-year high as the recent interest rate cuts boosted confidence among home buyers.
In the energy market, OPEC+ has agreed to delay its increases in oil output, originally planned for October and November. The statement came as crude oil prices hit their lowest level in nine months. But it did say that it could reverse this decision if needed. Oil prices have been falling over concerns of a weakening economy: the world's biggest oil importer – China – has reported softer economic data, and a US recession still cannot be ruled out.
Continuing with the theme of energy, tensions have been mounting in the South China Sea: Malaysian Prime Minister Anwar Ibrahim has refused to halt oil and gas exploration, leading to clashes with Beijing. China believes that Malaysia was infringing on its territories with the latter claiming that its exploration activities were within its boundaries.
Overall, the markets have rallied over the first eight months of this year. But as we head into the autumn and the US elections come into view, the picture becomes nuanced. Given uncertainties regarding economic data and the political backdrop, combined with ongoing geopolitical unrest in the Middle East and Europe, a pause or even a further correction in the markets would come as no surprise in the coming weeks.
That said, the fundamentals still support ongoing market expansion: inflation is moderating, the Federal Reserve Bank remains poised to cut interest rates, and economic growth – while cooling – is not in negative territory or recessionary. Lower interest rates obviously mean lower borrowing costs for both consumers and corporations, which could ultimately lead to a re-acceleration of economic growth and higher stock markets. So any period of stock market weakness should be leveraged as a buying opportunity for longer-term investors.
