On Monday, investors were greeted back from their nice summer weekend with a sea of red in markets worldwide. The losses were led by Japan’s Nikkei Index (indicated in red above), which was down over 12% on the day. US markets took a lesser plunge, with the Nasdaq (purple) and S&P 500 (blue) falling around 3%. So, what exactly caused these major market moves? Like any good financial event, it was a perfect storm with all of the right dominoes lined up.
Setting up the dominoes:
- Economic slowdown worries – On Friday, the monthly jobs report showed an uptick in the unemployment rate to 4.3%, the highest reading since October 2021. This came after the Federal Reserve kept interest rates unchanged in their meeting on Wednesday. With inflation seemingly tamed, many investors have become worried that the Fed has kept rates high for too long and economic cracks are starting to form. Prominent Economist and Wharton School of Business Professor Jeremy Siegel went as far as saying the Fed needs to make an emergency rate cut after this new data. CNBC
- Weak corporate earnings – Coming into this quarter’s earnings season, most companies and US stock indices seemed priced to perfection, with markets up nearly 20% on the year and valuations elevated. Much of this optimism has centered around the excitement around AI. As companies have been reporting their earnings to investors, many have become worried that the billions of dollars companies have invested in AI technology may take longer to turn into higher revenues and profits. WSJ
- Berkshire selling stock – Joining in on the stock selling is the most famous investor of them all, Warren Buffett. In their quarterly earnings filing, Buffett’s Berkshire Hathaway disclosed a major shift in their portfolio. Berkshire sold over $80 billion in Apple stock, over half of its holding in the company. They also reported a $3.8 billion downsize in their holding of Bank of America shares. CNBC
- Continued geopolitical concerns – With Israel confirming responsibility for the death of Hamas’ leader and a likely retaliation from Iran, a cease-fire in the Middle East seems even less likely now. NPR
Now that the dominoes are in line, we just needed one to fall. Enter the “Yen Carry Trade”:
Interest rates in Japan have been among the lowest around the globe for the better part of two decades, including a 12-year run with negative interest rates. As other countries, including the US, began raising their interest rates over the past few years, a new opportunity opened up for professional investors – a “carry trade.” The trade involves borrowing money in a currency with low interest rates (Japanese Yen) and reinvesting the borrowed money in a higher-yielding currency elsewhere (US dollars). This arbitrage trade became extremely popular and profitable for many hedge funds and other professional investors. Like any good trade, it was great until it wasn’t.
On Wednesday of last week, the Bank of Japan (Japan’s version of the Federal Reserve) raised its target interest rates and announced a reduction of government bond purchases in the future. This announcement caused the price of the Yen to rise and interest rate differences between Japan and other countries to narrow. As this happened, investors participating in the Yen carry trade rushed to reduce their positions in this trade. As billions, if not trillions, of Dollars & Yen rushed to find a new home, chaos ensued. The trades started to bleed into stock markets as these investors began selling their stock positions to cover losses in their currency trades causing the massive moves in indices across the globe. WSJ CNBC
The Good News:
Despite the worrisome jobs report from last Friday, economic conditions still look good. In fact, the Atlanta Fed’s GDPNow forecasting tool that provides an estimate of US GDP growth is showing an estimate of 2.9% real GDP growth for the third quarter of 2024. If that estimate ends up coming to fruition, many will be happy with that growth and less critical of the Fed’s decision to wait on rate cuts.
Another silver lining in a crazy week – US bonds did their job. Since the US stock market peaked in mid-July, the US Aggregate Bond Index index is up around 3% while the S&P 500 is down 6%, and the Nasdaq is down nearly 12%. It pays to have less volatile assets in a portfolio.
Financial Planning/Investment Strategy Corner:
Adding Context: This is normal. Stay Invested.
The chart above shows calendar year returns for the S&P 500 (in green) vs. the largest intra-year decline of each year (in red). Since 1980, the S&P 500 has averaged an annual return of 10.27%. Yet, the average decline in any given year is -14.27%. This multi-week decline is right on cue.
One last chart. Each time these pullbacks happen, we all think (including myself), “There is so much negative news, how will we get through this?” And each time, markets prevail. Not to say there won’t be more rough days, but there will certainly be better days ahead.
Now on to the fun stuff:
Quick Hits:
- Cocaine Sharks – 13 sharks have tested positive for high levels of cocaine off the coast of Brazil. BBC
- This got a Hampton Beach, NH-based marine biologist wondering: what kind of drugs are sharks in the Gulf of Maine on? Seacoastonline
- Pole vaulter’s record-breaking bonuses – Swedish pole vaulter, and world record holder, Mondo Duplantis receives a monetary bonus each time he breaks his own record, a feat he has done 8 times now, each time by 1 centimeter. Talk about gaming the system. WSJ
- From venture capitalist to Olympic gold medalist, Kristen Faulkner became the first US winner in the women’s cycling road race in 40 years. That is going to look good on her LinkedIn profile. WSJ
- To me, outer space is both fascinating and utterly terrifying. New photos released from the Chandra X-ray Observatory confirm both of those feelings. Smithsonian
Fun with the Portland Sea Dogs
Thank you to all who joined us for a fun night at the ballfield! It is always great to spend time with everyone outside of the office. If you were unable to join us for this event, we will certainly be hosting more in the future and hope to see you there!
Quote: “I was never in this for the money. But it turns out that the money was an absolute necessity for me.” Michael Scott, The Office
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