I admit that the key message of our recent mid-year update was easy: high volatility.
To that extent, the summer didn’t disappoint. August started with severe market turmoil, fed by a synchronized collection of concerns: US slowdown after weak employment and ISM reports, the rise of the yen threatening billions of ‘carry-trades’, escalation in geopolitics, renewed uncertainty in US politics and finally questions about the return on big tech’s massive investments in AI, which didn’t really impress in their quarterly earnings.
A few days later, markets started an impressive rebound with better economic data, encouraging prospects on inflation, and most crucially a dovish turn from Fed officials: rate cuts were not a question of ‘if’ or “when” anymore, but ‘how deep in September, how long then’.
As always with positive surprises for the monetary Masters of the Universe, all asset classes celebrated and concluded August in the green, with a chart of equity indices drawing an almost perfect ‘V’, for ‘Volatility’.
September so far hasn’t started well. Now that markets believe in imminent US rate cuts, they care about the second unknown of the goldilocks equation. We don’t just want rate cuts, we want them together with a resilient growth, a slow soft-landing.
Alas, growth concerns have taken center stage with monthly economic data. The US domestic leading indicators ISM were poor for manufacturing and not amazing for services. Then, the number of job openings disappointed.
Subdued job numbers
Finally, the most awaited monthly Non-Farm Payrolls (NFP) job report did not reassure last Friday. The initial July number of ‘only’ 114,000 job creations had shocked, and it shocked even more when the Bureau of Labor Statistics revised it to a terrible 89,000.
By comparison, August was decent with 142,000 job creations, even if it underwhelmed the consensus forecast of 165,000.
While market participants increasingly question the relevance of the NFP surveys, due to their constant revisions, they also ignored a no deteriorating unemployment rate, reassuring number of hours worked and even a slight increase in the average hourly earnings.
Growth anxiety dominates, and expectations for US rate cuts are radical: the market implied probability of a September double cut (-50 basis points) even briefly spiked to 70 per cent during an official’s speech on Friday, and the Fed Fund futures now imply -110 basis points of easing for 2024 alone. And a bit more in 2025.
The Fed is not seen any more as having perfectly engineered a prodigious combination of disinflation with an economic soft landing but is highly suspected of being ‘behind the curve’.
The only good news for markets is that another of our 2024 calls works: bonds have reconstituted their ability to smoothen equity risk, diversification is at play.
Last week alone, US Treasury yields dropped by an astonishing 20 to 30 basis points across the curve, with the 12-month dropping as low as 4.1 per cent, after having spent most of the first-half of 2024 above 5 per cent.
The 2-year is just below 3.7 per cent, and the 10-year is not far.
As a result, the entire asset class is now positive YTD, and well-balanced portfolios still show good 2024 returns, between 6% and 10% in our own shop. Still, volatility is not a pleasant experience, and only the most defensive assets are resilient.
All cyclical assets, from stocks to oil and industrial commodities, are suffering, and the dollar just turned negative YTD against its trade-weighted counterparts. For once, the perspective of easing and the actual drop in US Treasury yields do not benefit equities.
Their valuation was too elevated to expect further multiple expansion, and growth concerns are challenging their earnings prospects, especially with additional questions have risen on the hegemonic and beloved big tech sector.
So, what to do from now? First, don’t panic. This is not the first episode of growth anxiety, and many of early recession indicators are not flashing red at all.
Quit the daydreaming on rate cuts
This is also not the first time that markets are dreaming about oversized rate cuts: we indeed started 2024 with even more easing priced-in by futures. Taking a step back, we see a slowdown rather than an imminent recession risk; this is not a ‘bug’ but a ‘feature’ of Fed’s policy: the only way to combat inflation is to slow activity.
Stock markets are not crazily expensive under a soft-landing scenario; if anything, safe bonds are a bit rich.
In any case, we need more data, which will undoubtedly continue to fuel volatility, especially as the US election is approaching, another major source of uncertainty. Volatility is the bread and butter of day traders, but they’d better be right.
It is not too harmful for well diversified long-term investors, who can even benefit from opportunities for tactical tilts. But volatility is extremely hazardous for people in between: dear reader, don’t go all in and don’t try to time the market before an economic data.
Stay invested, stay diversified, stay safe.
