August 8, 2024
Last Friday, a weaker than expected July jobs report prompted a good ol’ fashioned global growth scare and de-risking move in the financial markets. In particular, the rise in the unemployment rate to 4.3% triggered the “Sahm Rule”, a recession signal with a perfect track record. Naturally, in the immediate aftermath there was a fair bit of hand-wringing that the Federal Reserve had made a mistake by not lowering rates at its FOMC meeting last week. Fed Fund futures are now discounting a bigger -50 basis point cut in September and -137 bps by year-end, up from -25 bps and -62 bps, respectively, before. There is also a rising expectation that the Fed may make an emergency move in-between meetings. We believe the macroeconomic data do not warrant such a move at this time. While the July jobs data was indeed softer than expected, it was still consistent with growth. It is also possible that Hurricane Beryl may have partially distorted the data, causing a temporary spike in the numbers of unemployed in the month. We’ll need to see another jobs report to confirm. More importantly, an emergency intermeeting cut at this point would more likely spark greater fear in the markets as investors are left to speculate on what the Fed may know.
The accelerated U.S. stock sell-off related to these renewed macro concerns, coupled with the Bank of Japan’s recent rate hike, led to an implosion of the “Yen carry-trade”, whereby investors borrowed cheaply in Yen and converted to U.S. dollars to invest in higher returning assets, including U.S. tech stocks. As U.S. stocks began selling off, the Fed began signaling an imminent rate cutting cycle, and the BOJ actually began raising rates, investors caught off-sides were forced to unwind those trades, which happened in a rather dramatic way this past Friday and Monday. The Yen surged upwards of 15% in the past several weeks as investors repatriated funds to pay off Yen-backed loans.
To add to the list of growing concerns, there is once again the risk of escalation in the Middle East, following Iran’s threats of retaliation and the U.S. moving military assets into the region. A newly tightened Presidential race following Joe Biden’s withdrawal has increased political uncertainty as we head towards the November elections. Lastly, many took note of Warren Buffett’s steps to raise significant cash, including disclosure over the weekend that Berkshire Hathaway has halved its Apple position in the past quarter.
Coming off elevated valuations and investor sentiment it is not terribly surprising that we saw such a large and sudden risk-off move. The rapid snap back in financial markets since Monday, including Japanese stocks, has provided investors some relief. Many pundits are now ascribing most of Monday’s panic selling to the unwinding of leveraged positions as described above. However, considering that we have now entered the seasonally most challenging period of the year for the stock market (August and September are historically the worst two months), we may not be completely in the clear just yet. We expect continued volatility in the coming months as we await additional data to better inform the outlook.
For now we continue to believe an economic soft landing and continued expansion in the economy and corporate profits remain the base case. We don’t expect the Fed to overreact, but it is in a position to aggressively respond to any further weakening. For a recession-induced bear market to materialize we will need to see additional evidence that the labor market is deteriorating further, including a spike in layoffs and unemployment claims. We have not seen this yet, but are mindful of the fact that historically this is precisely what the “Sahm Rule” has predicted – once the unemployment rate goes up a little, it usually goes up a lot.
Given this heightened uncertainty, we continue to believe our clients are well-served holding a diverse portfolio of financially-strong, high-quality, and reasonably-priced growth stocks. We do maintain some modest buying reserves, ready to be deployed in the event of additional market choppiness in the months ahead.