What In The World Is Going On With The Stock Market?
Aug 06, 2024A few short weeks ago, stock investors were partying like it was 1999, throwing caution to the wind, ignoring valuations and diversification, buying the hottest Artificial Intelligence (AI) story of the day, and, in many cases, employing massive amounts of leverage. But just because a handful of tech companies have grown to dominate their industry does not mean they must dominate our portfolios. There is no logical reason why an investor should own more of a certain stock simply because it represents a large weighting in its index. Benchmarks were introduced to measure performance, not to drive it.1
Fast forward to today, and it is an entirely different story. The Japanese Nikkei tumbled 12.4% on Monday after falling nearly 6% on Friday, bringing its month-to-date loss to almost 20%. Yes, that is month-to-date, and we are only five days into August! The unwinding of leveraged carry trades appears to be the culprit. Such trades are typically done by hedge funds that borrow in a currency with low borrowing costs and invest in markets with higher yields, such as the U.S.
Concurrently, U.S. markets have suffered in the last week as investors fretted about weakening economic data, particularly the release of the July Nonfarm Payrolls report. A few months ago, such news would be viewed positively by Wall Street, as it would have increased the likelihood of the Federal Reserve (the Fed) easing. As it stands today, with a noteworthy change in sentiment, the Fed will almost certainly ease at their next meeting, with the CME FedWatch Tool indicating more than an 80% chance the Fed will cut by fifty basis points. This is a shift from previous expectations. Just a week ago there was over a 70% chance of a twenty-five-basis point cut. Should market jitters continue, there is speculation by Wall Street that an intra-meeting cut (i.e., emergency cut) is in the cards.
As we have opined many times before, we do not believe that inflation has been conquered. Cutting rates too soon may make the inflationary battle more challenging to win. We believe the era of two percent or less inflation ended with the conclusion of the COVID-19 pandemic. We believe the new range for inflation will be three to four percent. We remain at the lower end of the range in terms of expectations, in line with our previous prognostications. At some point we do believe there will be a recession, and during that time, inflation levels will likely fall below that three to four percent band. However, we also believe it will likely pick back up once the economy begins to recover.
Accordingly, we will not be drinking the Wall Street Kool-Aid and pile into longer-dated bonds. All too often, as we have expressed in previous publications, we see Wall Street prophets forecast what they hope will happen instead of what will happen. We see excess risk in owning longer-dated bonds and no adequate reward. Granted, long-dated Treasuries will have their moment in the sun when a recession rolls around, but over the long haul, we see longer-dated bonds facing more headwinds than tailwinds.
With that said, you may ask: “When is the recession coming?” Pinpointing an exact date of a recession is not as easy as it sounds. However, with GDP still growing in that 2% range, declaring we are currently in a recession based on a handful of weak economic datapoints is premature. Moreover, periods of economic expansion typically do not end because of old age but rather an unforeseen event. The COVID-19 lockdowns caused the most recent recession. Prior to that it was the bursting of the housing bubble. Our next thought piece, which will be published in a week or so, will dive deeper into this subject.
Being overweight consumer staples and healthcare were a headwind for our equity strategies performance during 2023 and the first half of 2024. Recently, they have performed relatively well as economic uncertainty mounts. With that said, we will continue to survey the economic and financial market landscapes and will make portfolio changes when deemed appropriate. We do not, however, view the current landscape as particularly dire as we alluded to above. Instead, we see the markets returning to a more normalized environment. We also believe this rotation may provide an opportunity to buy a few quality names on our watchlist that were previously deemed overvalued.
We understand that market volatility can be upsetting and stressful. As a reminder, our investment team and their families have a sizeable portion of their funds invested in the same stocks as our clients.
Pockets of Wall Street appear to have turned into a casino. Investors were all in on the AI trade, using leverage to increase their returns. It worked until the unwind of the Japanese carry trade forced traders to sell higher risk assets purchased under more favorable conditions, exacerbating the losses in the markets given the concentration of risk assets in the broader indexes. Please make no mistake … we Invest, not Speculate. Market corrections are nothing new. Portfolios that are diversified (not overly concentrated) and invested in stocks that represent modest valuations tend to hold up better over the long term than those that invest in the latest fad.
Please reach out to your MAP representative with any questions or concerns.
Managed Asset Portfolios Investment Team
Michael Dzialo, Karen Culver, Peter Swan, Zachary Fellows, John Dalton, and Nicolas Vilotti
August 6, 2024
Certain statements made by us may be forward-looking statements and projections which describe our strategies, goals, outlook, expectations, or projections. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. The information contained herein represents our views as of the aforementioned date and does not represent are commendation by us to buy or sell this security or any other financial instrument associated with it. Managed Asset Portfolios, our clients and our employees may buy, sell or hold any or all of the securities mentioned. We are not obligated to provide an update if any of the figures or views presented change.
