August Market Update

After a long period of unusual quietness in equity markets, the US S&P 500 equity Index fell -6% in the first 3 trading days of August and the Japan’s TOPIX index collapsed by over -20%. Since then we have, I am happy to say, seen the start of a recovery in prices. That said, here are a few thoughts on the return of volatility this August:

 

1. The US market move is (so far) a pretty normal event. The current drawdown of around 8% is still below the average for an average year (see the chart below). If the move stays below 10% it is more of a buying opportunity over the subsequent 3 months than a reason to sell. Goldman Sachs calculates that since 1980, an investor buying the S&P 500 index 5% below its recent high would have generated a median return of 6% over the following 3 months, enjoying a positive return in 84% of episodes. There are no guarantees of course but, for the US and Europe at least, I am not sure we have seen much out of the ordinary yet.

 

 

1. This is not, of course, true for Japan. Japanese equities (measured by the TOPIX Index) fell -6.5% on Friday 2^nd August, then fell another -12.1% on Monday and then rose +9.3% on Tuesday. The culprit here though is not equity market investors but instead levered currency investors. I don’t want to get into the details on the Yen carry trade here (here is a decent explainer for the interested), but the important point is that the Japanese Yen has been on a multi-year weakening trend compared to the US dollar. The Bank of Japan finally intervened to make the Yen stronger at the end of July. This forced levered currency investors to sell their shorts and push the Yen even higher. A stronger Yen means lower international earnings for Japanese companies and hence lower equity prices. Plenty of levered Japanese stock market investors were then forced to sell into a down market too.

 

The point here is that it is all pretty technical. Once the levered positions have been washed out you should see some return to normality, which has been the case. After the recovery in Japanese equities, their returns are broadly in line with other major markets for the quarter so far on an unhedged currency basis.

 

2. If this is all sounding benign, what is there to worry about? First, the US sell-off was triggered by a weaker than expected jobs report on Friday. We have written a few times that we think the risk today is that there is a growth slowdown rather than any re-acceleration in inflation. Well, the slowdown looks like it might be arriving. If the current trend keeps in place then the recession that many thought we might avoid might actually take place. I think it is too early to be overly gloomy about this but, as ever, we shall see.

 

In the meantime, it is worth noting that the diversifying assets we own are doing their job to hedge against equity market moves. Both our fixed income and alternative investments are up for the quarter. Unlike 2022, there is some proper diversification away from falling equity markets and so far this quarter this diversification has worked.

 

3. The second risk I would flag is that I am a bit more cautious than I would normally be about the next 3 months. September and October are often volatile months for equity markets and my experience is that the sorts of spikes in volatility we have seen so far this month are often harbingers for more ahead. The trend of growth deceleration remains in place. In spite of the evidence on 5% drawdowns I gave above (and the bounce in equities we have seen so far this week) we are not buying the dips here for our client portfolios. It often pays to be brave in this business but the months ahead might offer better opportunities for the courageous.

 

Chris Brown, CIO

cbrown@ipscap.com

The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.