Market Update: Negative Sentiment Spreads Across Markets
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Article Type
Market Updates
Topics
Macro, Opinion
Published
August 05, 2024
Read time
5 mins
Authors
Jacob Vijverberg, CFA
Jordy Hermanns, CFA
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Since the start of this month, financial markets have experienced a notable risk-off dynamic. In this article, we present a brief update on recent developments.

 

In the first days of August, sentiment in financial markets turned negative. Equity markets sold off, and interest rates declined. Global equities dropped on Thursday and Friday, ending the week 2% lower. US 10-year yields fell by 40 basis points over the week. These trends continued on Monday, with global equity markets declining another 3% and yields dropping further. US markets have lost about half of their year-to-date (YTD) returns, while European markets have erased all YTD returns and are now trading around levels seen at the start of the year. Credit markets have followed this pattern, with widening spreads in August, which were still at cycle lows in July.

 

So far, the Japanese market has recorded the biggest loss, with the Nikkei closing 12% lower on Monday. Especially the Japanese banking sector is under pressure. TheTopix Banks Indexplummeted 26% in the past two sessions. Globally, IT-related stocks are experiencing larger losses. The Nasdaq 100 lost 10% of its value in three days, and some specific equities are under strong selling pressure.

 

This aggressive turn in market sentiment can be attributed to several factors. One main factor is the increased risk of a US recession. In the past few months, the US economy has lost some traction. Last week, new data was relatively weak, and on Friday, US labor data surprised on the downside. This fits into a picture of a cooling US economy and worsening business conditions. This is significant, as investors no longer priced in a hard landing of the US economy. Instead, many expected the economy to experience no landing at all despite the still very restrictive monetary policy. Even a slightly larger chance of a harder landing would therefore warrant a downward adjustment in financial markets.

 

Another important theme is the general market conditions. In the run-up to the current selloff, risk markets experienced an exuberant phase in which investors expected very strong earnings growth in AI related companies. Equity markets, especially AI-related stocks, reached new highs earlier this year. These developments coincided with relatively strong earnings. However, share price increases vastly outpaced earnings, leading to higher valuations. These periods of overenthusiasm raise the risk of sell-offs if high expectations are not met.

 

Another specific factor involves positioning in financial markets. It appears that the market was crowded with speculative carry trades. Speculators invested in high-carry assets and shorted low-carry assets, often using Japanese assets as the low-carry instrument due to Japan's low interest-rate environment and more attractive yields in other parts of the world. Last week, the Bank of Japan surprised the market by tightening monetary policy, causing a rapid unwind of these carry trades. This explains why Japanese assets have experienced more selling pressure.

 

Weaker economic data has fueled expectations of central bank interventions. The ECB lowered interest rates in June, and expectations for further easing have increased. Additionally, there has been a strong repricing in US policy rates. Last week, the market was discounting a 65 basis point change in the Fed rate by the end of the year, which has now increased to 125 basis points. Market expectations for a September cut have solidified, and even a short-term rate cut outside of the Fed meeting cycle is being priced in.

 

Our view is that the current correction is mainly a normal correction from too exuberant levels and excessive speculative positioning. A slowdown or even recession in the US is quite likely in our view, considering the restrictive monetary policy and the winddown of savings and fiscal stimulus. For now, we therefore remain prudently positioned.

 

That said, in the longer term the earnings power of AI- and IT-related companies remains strong. Any more significant pullbacks would therefore be an opportunity to selectively buy attractive assets at more reasonable prices.

Disclosures

Authors

Jacob Vijverberg, CFA
Head of Asset Allocation

Jacob Vijverberg, CFA, is head of asset allocation. He is responsible for both strategic and tactical asset allocation. The team is managing a wide range of multi-asset funds  

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Jordy Hermanns, CFA
Portfolio Manager

Jordy Hermanns, CFA, is a portfolio manager in the multi-asset group and serves as an investment strategist in the asset allocation team.

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