Knowledge Center
Market Currents – 8/12/24
- July’s Gains Mask a Shifting Market. July concluded on a positive note, with the S&P 500 notching a third consecutive month of gains. A closer examination unveils a shift in market dynamics, though. Growth stocks, including the previously high-flying “Magnificent Seven” tech giants, stumbled a bit against value sectors. The start of August brought some market volatility, casting a shadow over the market’s path forward. Meanwhile, bond prices climbed higher as yields fell.
- Finding Zen in the Yen’s Rise. Departing from the global trend of central banks easing monetary policy, the Bank of Japan increased its key interest rate by 25 basis points. This move aimed to counteract the Yen’s slide against the Dollar, a depreciation that is fueling record inflation in Japan. However, this policy move triggered an unwinding of the global “carry trade,” a popular strategy among hedge funds that involves borrowing in low-interest-rate currencies like the Yen to invest in higher-yielding assets elsewhere, often amplified by added borrowing. As the Yen strengthens, these leveraged investments are now facing losses. Traders are forced to sell off their assets to cover these losses, causing a ripple effect of selling and a sharp, fast downturn in global risk assets.
- Economic Jitters Complicating Carry Trade Unwind. A series of lackluster economic reports, including the disappointing July nonfarm payroll jobs report, has reignited investor fears of a not-so-soft economic landing. Combined with an improving inflation trend, the market is expecting the Federal Reserve to commence its interest rate easing policy beginning with the September meeting. Such a move would likely weaken the Dollar, potentially accelerating the further unwinding of carry trades.
- Q2 Earnings Season: A Tale of Resilience and Adaptation. The Q2 earnings season has largely drawn to a close, and while results generally surpassed expectations, a key theme has emerged: a dichotomy between revenue and profitability. FactSet reports an impressive 11% year-over-year earnings growth rate, marking the strongest performance since Q4 2021. Revenue gains, though solid, have fallen short of forecasts, while earnings and margins are comparatively stronger. Companies have been prioritizing cost controls to navigate a shifting demand landscape. Flagging consumer demand is most apparent among lower-income households.
- Bottomline: Market Volatility is Normal, Opportunities Remain. Market fluctuations are an inherent part of the investment landscape, and can be healthy for the long-term health of the market. Despite the recent sell-off, the market has merely retraced its steps to mid-June levels, and remains positive for the year. Economic fundamentals, though slowing, are far from collapsing and not as dire as the market’s reaction might suggest. Globally, monetary policy is easing (except in Japan), which should ultimately provide a tailwind for risk assets. For now, the recent volatility seems more rooted in the global unwinding of carry trades, triggered by margin calls and leverage, rather than a fundamental deterioration. Still, caution is warranted as we navigate the traditionally quieter summer months, where any news can have an outsized impact on the markets. We remain vigilant, actively seeking opportunities that may emerge from this volatility.