Although financial markets have bounced back after an unexpected tumble around August 5, there are wide concerns about ongoing volatility and a possible US recession. How worried should you be as an investor?
If you’re a long-term investor – say in your early thirties investing for retirement 30-odd years away – you shouldn’t be worried at all. In fact, you shouldn’t even bother reading this.
The people I think about when discussing the financial markets are short- to medium-term investors and pensioners, to whom shorter-term market movements do matter.
If you’re a pensioner who has a relatively large proportion of your retirement savings invested in higher-risk assets such as local and offshore equities, market volatility and negative performance matter a lot, because you may not have the time for the markets to compensate you for any loss.
You must remember that sharp falls are not especially unusual in equity markets. Simon Webber, head of global equities at Schroders, says: “The recent violent sell-off must be seen in the context of exceptionally strong equity markets since October 2023 and a correction is perfectly healthy and normal.”
It’s also amazing how short our memories are. In South Africa we’ve seen the rand declining in tandem with our weakening economy over a number of years while the US economy has boomed, and we’ve become lulled into a “local is weak, offshore is strong” mindset. But suddenly the reverse seems true: although the rand remains weak, the mood of the country has changed since the election, with an optimism in the business community that we have not seen since the “Ramaphoria” of 2018.
It was the Japan stock market that triggered the market tumble, but there were other factors involved: high valuations of the big US tech stocks, a blip in employment data coming out of the US, worries about when the US Federal Reserve (Fed) will begin its interest-rate-cutting cycle.
George Brown, senior US economist at Schroders, says: “The problem is that in June the Fed signalled only one rate cut this year. That was too hawkish and left it unable to pivot swiftly in July. The Fed may cut by 50 basis points in September to make up for lost time. But the market is now pricing in five cuts in 2024, which is an overreaction.
“In many ways, the recent weaker labour market data shows that higher interest rates are working as intended: if rates are restrictive, you would expect the labour market to soften.”
What happened in Japan?
On July 31, the Bank of Japan unexpectedly raised interest rates to 0.25% from the previous 0-0.1% range. When combined with the weaker US data, which was prompting a cut in rates, this caused a sharp strengthening of the Japanese yen, which, in turn, sparked further market volatility.
Japan bore the brunt of the selling pressure, with the Nikkei bourse down 12.4% on Monday August 5. But the Bank of Japan’s move was not all bad news for equities. Taku Arai, deputy head of Japanese equities at Schroders, says: “A reversal in yen weakness, coupled with wage growth, is expected to support consumption going forward. Based on these economic trends, we maintain a positive outlook on the earnings strength of Japanese companies as a whole.”
The US economy
US corporate earnings for the second quarter have given little cause for alarm. Webber says: “Second-quarter earnings have been fairly robust across major equity markets, though with pockets of consumer weakness apparent. Recent market moves largely represent a de-rating in equities to reflect a more uncertain outlook for the US economy, bringing US equity valuations down from elevated levels that we have been flagging for some time.”
Tina Fong, strategist at Schroders, points out: “Earnings growth has been good at 14%, which is above what consensus was expecting going into this earnings season. It seems the market has been disappointed that the scale of positive earnings has been more muted compared to previous quarters.”
Upside for South Africans
Anthea Gardner, founder and managing partner at Cartesian Capital, says the upside of the US cutting rates to avoid a recession could mean a stronger rand, or that our South African Reserve Bank’s Monetary Policy Committee could feel that they have the leeway to also cut rates. “Lower interest rates also means that our indebted companies can perform better, and you and I can afford that little weekend treat, or pay down our debt,” she says.
What to do?
I don’t think we have too much to worry about, apart from being over-invested in overvalued US tech stocks.
The last word goes to the ever-insightful Izak Odendaal, investment strategist at Old Mutual Wealth, whose weekly economic report is a must-read for serious investors.
“Market volatility is never pleasant, but one benefit is that it forces investors to grapple with the assumptions they’ve previously held. If those assumptions have changed, it might call for a different asset allocation. If not, it is best to just stay the course. The biggest mistake is usually to react to the market volatility itself, instead of to perceived changes in the fundamentals. A US hard landing still seems unlikely, but economic growth is cooling. Elsewhere in the world, such as South Africa, it is picking up speed. A valuation-based approach does not protect against such volatility in absolute terms, but it does help to avoid some of the big air pockets. It also helps investors to keep a look out for opportunities where the market overreacts,” Odendaal says.
BUSINESS REPORT