Market Volatility

August 8, 2024

I am sure you saw the headlines.

After hitting new highs last month, markets dropped dramatically, erasing months of gains.

It feels like the sky is falling.

Then, the markets skyrocket right back up just days later. It’s glory days again.

Let us take a step back and look at what is going on.

What is behind the market volatility?

A couple of significant factors fueled this latest merry go round:

Weaker-than-expected economic data sparked recession fears. 

July’s soft jobs report triggered a recession indicator that caused U.S. stocks to sell off in fear. Though it does not appear that the U.S. is in a recession now, weakening economic data is increasing the risk that a recession will strike. If this is the case, there is a fear that the Federal Reserve is now having to play catch up with its interest rate policy and doesn’t have the grasp on the situation investors believed just weeks ago. Then later in the week, the market rallied significantly on better than expected jobs data indicating the economy isn’t on the precipice of a recession. Dizzy yet?

2. Speculative currency trading by corporate investors. 

“Carry trading” is a strategy that involves borrowing money in a currency with a low interest rate (such as the Japanese yen) and reinvesting the money elsewhere where returns are higher. This strategy has been immensely popular for decades with hedge funds and institutional investors because of Japan’s consistently low interest rates. It is what we also call a “crowded trade” since so many institutions have the same position.

Its success depends on cheap borrowing currencies and low market volatility. However, that strategy is no longer paying off. Japan’s central bank recently hiked interest rates, which caused markets to grow more volatile, hitting traders with a double whammy (very technical word).

The “unwinding” of many of these positions triggered a global selloff as many traders sold the same positions to cover losses resulting in huge volumes and large price swings. Think of a doorway in a theater when someone yells “fire;” there isn’t enough room for everyone to get through at the same time.

Hard investing truth: There is always a reason to sell.

Markets are always waiting for the next opportunity to melt down. That is part and parcel of being an investor these days.

There will always be something happening (I call it “noise”) that can cause anxiety, fear, and the knee-jerk desire to sell. Noise can also push people to buy things at times and prices they shouldn’t as well; often called FOMO or fear of missing out.

Anytime you involve emotions with investing, it is a recipe for a disaster. We all know panic selling in response to a market stumble is wrong but there are still so many investors that can’t help themselves. That is why having a disciplined process is so important.

Selling and sitting on the sidelines typically means missing the best market days as investors sell the dip and the markets turn positive again.

Though markets bounced back quickly this week, we believe the volatility will continue.

It is quite common for markets to experience a selloff after reaching historic highs. Tech stocks have had an historic run in the last 18 months, and it isn’t uncommon for a correction to take place. One of the reasons we rebalance portfolios (trim stocks that have had strong 6 months performance and add to stocks have underperformed for the past 6 months) twice per year is to take advantage of these scenarios. So, over a month ago and prior to this most recent decline, we reduced our overall exposure to tech and increased it to areas like utilities and real estate.  Coincidentally, the tech sector is down over 16% in the last month while the utilities and real estate sectors are both up over 5% (it usually isn’t this glaring an example).

This rebalancing process allows us to trim high (think “sell high”) except we only sell a portion of the position and add low (think “buy low”) except we are simply adding the money we took from the stocks we sold “high” and adding to those stocks we believe are “low.” This is a disciplined, emotionless process we complete twice per year (once in the winter and once in the summer). It helps reduce risk in portfolios and can often add incremental performance as well (see last sentence in paragraph above).  

As always, we are closely monitoring the data, including possible Federal Reserve decisions that could move markets.

We will be in touch with updates as we have them.