There is an expression that says, “stocks take the stairs up but the elevator down”.
So after almost 2 years of good “stairs up” returns, stocks have recently taken the elevator down. Over the past 3 weeks, global equity markets have declined by 8% with volatility recently hitting levels we have not seen since 2020.
A combination of recent events/news have increased uncertainty about the outlook.
To name a few:
- 7/31 Israel Attack: Israel killed Hamas leader Ismail Haniyeh on Iranian soil.
- Market Interpretation: Fear of Middle East escalation and potential impact on oil prices. Geopolitical risk may rise.
- 8/1 Poor ISM Manufacturing Data: Lowest since November at 46.8. Below 50 is considered contraction. Manufacturing is not a large portion of the economy, but a large portion of earnings.
- Market Interpretation: Fed may have waited too long to lower rates.
- 8/2 Weak Jobs Report: 114k additional jobs, well below expectations. Unemployment up to 4.3% from 3.6%. Still positive job additions, but softening.
- Market Interpretation: The popular “Sahm” rule* was triggered. Fed may have waited too long to lower rates. (* The Sahm Rule, is a time-tested and widely recognized indicator of the onset of a recession and is based on the three-month moving average of the U.S. unemployment rate being at least half a percentage point higher than the 12-month low.)
- 8/5 Japan “Black Monday”: Japanese markets fell 10%+ marking the worst day since 1987 following America’s Black Monday. The “carry trade” of using inexpensive Yen to purchase other assets is to blame. Trigger: a Bank of Japan rate hike on 7/31
- Market Interpretation: Predictable global monetary policies can no longer be assumed.
Since the peak in prices on July 16th, global equity markets have corrected by 8%. In our opinion, this is a needed and healthy pullback that will help restore value and create opportunities for long-term and patient investors. In fact, air pockets like we are experiencing right now should be expected as they have always been part of the investment journey. Historically, 5%-10% corrections happen once a year on average.
It is possible that the current pullback lasts longer and becomes more severe. Historically however, 20%+ equity corrections have generally been associated with recessions. We don’t believe we are in a recession and don’t believe it is the most likely scenario ahead. The long and variable lags of tighter monetary policy may finally be having the impact contemplated (slowing inflation, slowing economic growth and slowing employment) but it hasn’t killed the economy. More importantly, the Fed now has room to shift to a more accommodative monetary policy which should help cushion a potential downturn in the economy.
In the equity portion of portfolios, we continue to hold some defensive positions to help cushion the downside when markets sell off. Our preference for domestic and higher-quality equities in the current environment is also important and beneficial. In fixed income, our focus on high-quality bonds (not credit) has led to solid price appreciation in recent weeks. Said otherwise, fixed income is acting defensive and helping provide diversification when needed.
Our takeaway: Don’t panic. Stay invested. Enjoy the summer and stay focused on the higher horizon ahead.
