August 2024 Market Update

After a rough week in the global markets, the Japanese stock market experienced a significant drop of 12.4% last night—the largest single-day loss since the 1987 crash. This downturn spilled over into our markets today, with the S&P 500 losing 3% and the NASDAQ Composite falling by 3.43%. At the lows, both indexes were down close to 6% this morning, but they recovered somewhat during the day. The volatility index (VIX), often referred to as the fear gauge, rose to over 60 this morning and closed just above 38. To put that in perspective, the VIX has mostly traded between 11 and 15 over the last year. We haven’t seen a reading this high since the economic shutdown during the COVID crisis.

What's Behind The Selloff?

A combination of factors has contributed to the selloff. Last week we received some negative economic news indicating that the U.S. interest rate hikes are finally impacting the economy. The July employment report showed a deceleration in job creation, and the unemployment rate climbed to 4.3%. The ISM Manufacturing Index also came in at 46.8, below every economic forecast Bloomberg received, marking the lowest level since the COVID lockdown. Any report under 50 indicates economic contraction. Lastly, despite the majority of positive earnings reports this season, a few large technology companies either missed earnings expectations or lowered their guidance.

The Carry Trade

Globally, one of the most significant investment strategies over the last 30 years for hedge funds and large institutions is the Carry Trade. In simple terms, this involves borrowing money at a low interest rate and reinvesting it for a higher return, often using foreign currencies and leveraging. Since interest rates in Japan have been virtually zero for 30 years, the Yen has been the most popular currency for this trade. Last week, the Bank of Japan surprised the world by raising interest rates for the first time in 17 years and adopting a hawkish stance. The Yen was already strengthening against the dollar, gaining more than 10% in weeks. Due to leverage, when these trades go against you, margin calls require asset sales to cover losses, potentially starting a domino effect. The estimated value of the Yen carry trade is over $4 trillion, making it a significant issue. Institutions typically sell their most liquid assets first, like stocks, bonds, and cryptocurrencies, to cover losses. For example, Bitcoin is now down ~20% in a week.

What Now?

Once the Yen carry trade unwinds, global markets will return to trading based on normal fundamentals and technicals. The VIX index typically doesn't stay at elevated levels for long. Despite recent economic weakness, U.S. fundamentals have been relatively strong. If the economy continues to weaken, the Federal Reserve has hinted at a potential rate cut in September. Historically, when the Fed cuts rates due to economic weakness, the cuts are gradual and last around two years on average. Ultimately, this will depend on economic conditions, inflation trends, and employment data.

Staying the course and continuing to invest during market volatility can be unnerving but often results in greater accumulated wealth over time. If you have any questions or concerns about your investment goals or risk tolerance, please don't hesitate to reach out.