Market Flash
After a depressing July, the equity markets began August with a sharp decline. Many indices have now entered a correction (i.e. a trend reversal associated with a drop of more than 10%), and the Japanese indices, down by more than 20% over a month. The VIX, the US stock market volatility index, exceeded 60 on August 5, a level not seen since the Covid crisis, and before that since the 2008 crisis.
What happened?
Although the last two weeks of July saw a gradual deterioration in sentiment, the sharp downward acceleration at the beginning of August is due to four catalysts that occurred almost simultaneously:
• Growing concerns over US growth: in recent months, markets had become used to taking US economic disappointments as good news, believing that this would support a more accommodative stance from the US Federal Reserve (Fed). Now that it seems a foregone conclusion that the Fed will start cutting rates at its September meeting, investors are once again beginning to view poor macroeconomic figures for what they are: cause for concern about the trajectory of growth. The latest US employment report, marked by a surprise rise in the unemployment rate to 4.3% and the activation of the so-called “Sahm’s Rule”[1] recession signal , served as a catalyst for this change in market sentiment.
• A sharp surprise rate hike by the Bank of Japan: on July 31, at the end of its last meeting, the Bank of Japan announced an increase in its main key rate from 0-0.10% to 0.25%, whereas investors were expecting a status quo. In response, the yen reappreciated sharply against most currencies, reaching 143 yen to the dollar, close to its level at the start of the year, compared with nearly 162 at the beginning of July. As a result, Japanese equities, which had risen sharply since the start of the year thanks in particular to the continued weakening of the Japanese currency, suddenly collapsed. Thus, after gaining up to 27% since the beginning of the year (inlocal currency), the Nikkei is now down -5% YTD[2].
• Doubts about America’s tech giants: after half-hearted publications from some of the “Magnificent 7”,notably Microsoft (disappointing results from the cloud division) and Amazon (poor consumer results in all regions of the world), a rumor about the star stock of recent quarters, Nvidia, has set the world alight. According to specialist media outlet The Information, citing anonymous sources at Nvidia and Microsoft, the American giant’s new processor, called Blackwell B200 and dedicated to artificial intelligence tasks, will see its release, scheduled for the very next few months, pushed back to early 2025. This prospect is already causing investors to fear further bad news when Nvidia publishes its quarterly results on August 28.
• Intensified geopolitical tensions in the Middle East: following the deaths of the Hamas leader and a senior Hezbollah commander in attacks presumably directed by Israel, the situation in the Middle East hardened considerably, raising fears of a military escalation involving Lebanon and Iran. Many Western countries have called on their citizens to leave these two countries, while the USA has stepped up its military presence in the region. While the potential consequences in economic terms are unclear at this stage, the prospect of a possible large-scale military conflict in the Middle East adds to the risk premium in an already particularly febrile environment.
Can the situation continue to deteriorate?
The reasons for this sharp fall in equities are therefore fundamental, and concern two major issues for the future trajectory of the markets: the dynamics of the US economy (and the increasing risk of recession) and the outlook for the technology giants, which have buoyed the markets for the past year and a half. Nonetheless, the panic reaction seen over the past few days may be exaggerated, and there are a number of factors that put it into perspective:
• This correction took place against a backdrop of very high markets and large accumulations of speculative positions (including short positions on the yen). The sudden unwinding of these positions, combined with the traditionally more limited liquidity of the summer months, probably amplified market movements.
• The US economy is undeniably on a downward trend which could become worrying. Nevertheless, last week’s very poor employment report, which served as the catalyst for the market’s accelerating decline, is possibly biased by one-off effects. In particular, the number of workers laid off for weather-related reasons reached an exceptional level in July (461,000 vs. 41,000 on average for that month of the year). The US labor market has certainly entered a phase of deterioration, but the situation at any given moment may not be as bad as the latest figures suggest.
• Information about Nvidia remains at the stage of rumors for the time being – although these have not been contested by the company – and there is no indication that the potential delay is sufficient to jeopardize Nvidia’s growth trajectory and cause major harm to its clients.
What do we do in this context?
The market capitulation of the last few days seems particularly exacerbated although, as we explained earlier, some of the triggers are to be taken seriously. At this stage, therefore, we feel it is important to adopt a cautious approach, without over-reacting to short-term movements.
In our diversified funds, for example, we maintain moderate levels of equity exposure as well as significant bond exposure, which in part helps to protect portfolios against a backdrop of sharply easing interest rates
We also remain reasonably confident in defensive stocks, which benefit from earnings visibility, healthy balance sheets and reasonable valuations.
Written on August 5, 2024 – Enguerrand Artaz