What is driving the global stock sell-off?

Markets overreact as US economy shows signs of cooling

Investors have been looking to ‘safe haven’ assets as a global equity market sell-off gathered pace this week.

This new-found investor caution appears to have been triggered by US jobs and unemployment data released on Friday, which painted a more negative picture than expected. This data led to market participants calling in to question whether a ‘soft landing’ (where the economy slows but avoids a recession) is possible. As a result, interest rate markets are now pricing in a higher probability of faster rate cuts, with the central outcome of ~2% of cuts over 12 months in the US (European markets are pricing fewer additional cuts). This has been exacerbated by the cooling of enthusiasm around the artificial intelligence theme in the latter part of July. A significant appreciation in the Japanese yen driven by a Bank of Japan rate hike impacted Japanese equities in particular. The BOJ rate hike drove investors to unwind carry trades, which involve borrowing where rates are low and investing in assets that provide a higher rate of return, exerting selling pressure on markets worldwide.
 
Markets overreact as the economy cools
 
While recent economic data does suggest a slight cooling in the economy, we caution against placing too much emphasis on individual data points like this as there can be significant noise in the numbers. The size of market reaction appears large relative to the data observed – we have seen other instances in the past couple of years of large market movements in response to relatively modest news. Overall, we see the economic data as remaining consistent with a moderate, if slowing, global expansion. The shift in investors’ expectations towards faster interest rate cuts is consistent with our views.  
 
We expect to see periods of volatility in markets as central banks navigate the path to cutting interest rates. We still believe our portfolio strategy combining diversification, assets providing protection and taking advantage of market opportunities through active management will provide strong outcomes. 
 
It is important to remember that these recent negative market moves follow a protracted period of positive returns for both bonds and equities. While the fall in equity markets over the past few days has been quick and sharp, it has only returned equity markets back to levels seen in May this year. Until 24 July, the S&P 500 had produced its longest period without a 2% or more daily decline since 2007, and investors may have become complacent. At this stage, it is hard to form a view on how far these dynamics will take markets.  We do not currently see evidence of a material increase in recession risks, but we are keeping this point under close review.

Our view

Our investment strategy at atomos is to focus on active management and diversification across different asset classes as an important way to reduce risk. Genuine diversification is the best tool we have at our disposal to design robust portfolios that can navigate a wide range of economic environments and insulate against market falls.