Zoom out in times of market volatility

Sensationalist headlines dominated the news this week amid major movements across different asset markets. Headlines like “Global markets panic on signs US economy is slowing” (source: NY Times) have contributed to investor worry. You’d be forgiven for having concerns around what this means for your portfolio given some of the press but below we explore why you shouldn’t always take these sensationalist headlines at face value.
 
To acknowledge the headlines, there has been a lot going on in global markets and economies. In global economic news, the Bank of England began its rate-cutting cycle, the Federal Reserve held rates steady, and the Bank of Japan raised rates while reducing bond buying. Key market movements over the past week or so have included declines in equity markets, falls in developed market bond yields (which pushes up the price of bonds) and a notable appreciation of the Japanese Yen. Bumpy markets have persisted, with particularly large downward then upward moves in Japanese equities. One key trigger for the market sell-off was worse-than-expected US jobs and unemployment data which casted doubt on a “soft landing”, a cyclical slowdown that comes to an end without a recession phase, for the economy. Cooling enthusiasm for AI following earnings reports from major tech companies like Apple and Amazon also impacted market sentiment.
 
Despite recent economic data indicating the global economy is starting to take its foot off the gas, the market's reaction seems disproportionate to us. Overall, the data release aligns with a moderate, albeit slowing, global expansion. And we have seen some reversals to the negative market swings earlier in the week. We could see more reactions like this later in the year particularly as central banks navigate further interest rate cuts trying to tread the tightrope of not allowing inflation to get back out of control, but reducing policy rates enough not to tip economies into recession.
 
To put the recent market decline into context, the falls have come after a period of extremely positive returns for bonds and equities. The global equity market only dropped to levels last seen in May this year. Until July 24, the US stock market had avoided a daily decline of more than 2% for its longest period since 2007, potentially leading to investor complacency. These statistics are intended to remind investors to look past the attention-grabbing headlines and look at any declines in a wider context and look at performance over a long-term time period. This is important for several reasons:
 
•    Markets will rise and fall – Reacting to every news piece and blips in short term performance can lead to poor, emotion-driven decisions.
 
•    Lower transaction costs – Frequent trading in response to market noise can increase costs and erode returns. A long-term investment approach involving sitting tight during short-term performance blips can minimise these costs.
 
•    Avoiding market timing – Trying to predict market movements is difficult to do consistently well as part of a good investment strategy. After all we are investing, not trading!
 
•    Aligning with financial goals – Investment goals are typically long-term, such as retirement or buying a home and decisions should support achieving these goals rather than reacting to short-term market movements.
 
There have also been news headlines about the fall in Japanese equities being “the largest percentage one-day drop since October 1987” (Source: CNN). This is true, but there are some nuances that must be observed to check how this could affect the value of your investments. We mentioned earlier that there was a notable appreciation of the Japanese Yen (one Yen now buys you more pounds or more US dollars than it did before). This is important as if your Japanese equities are held in a fund where you are exposed to (affected by fluctuations in the exchange rate of) the Yen, your fall in Japanese equities will have been partly offset by the currency becoming more valuable. So again, there can be more to these news headlines than initially meets the eye.  
 
Historical data shows that markets generally trend upward over the long term despite short-term wobbles. Investors who remain invested through market ups and downs tend to achieve better long-term performance. Genuine diversification is crucial for designing a robust portfolio that can navigate various economic environments. While market declines are challenging, it is important to "zoom out" and focus on the big picture. We show an illustration of this in the graph below. The moral of the story is to keep calm and carry on!

The Noise

• New applications for unemployment benefits in the U.S. dropped more than anticipated according to data published this week, easing concerns about a potential breakdown in the labour market. It was a welcome reversal of last week’s surprise sharp jump in jobless claims, which contributed to the heightened market volatility we saw this week. The fall in jobless claims likely reflects the fading impact of temporary car manufacturing plant shutdowns and Hurricane Beryl. Jobless claims have been trending upwards since June, with the data point closely monitored by the Federal Reserve. With markets 100% expecting a rate cut at the next Fed meeting in September, it did scale back its expectations of a bigger-than-usual 50-basis-point reduction after the data release, from 70% to 54% likely.

• British house prices rose by the most in six months in July, per figures published this week by mortgage lender Halifax. The 2.3% annualised increase suggested there was fresh momentum in the property market, with the last time house prices increasing by more than that on an annual basis being February 2023. On a monthly basis, prices jumped 0.8% in July from June, higher than the 0.3% rise expected by economists. Though a key part of the Labour party’s plan is to reform Britain’s planning system and speed up home-building the shortage of supply is likely to remain a factor driving house prices in the medium term. The Bank of England cutting interest rates from record highs last week will see mortgage rates drop, supporting the view for house prices rising.

• The carbon offset market is facing fresh turmoil after a significant category of credits failed to win approval from a crucial oversight body. The Integrity Council for the Voluntary Carbon Market has decided that its Core Carbon Principles label can’t be used on carbon credits issued under existing renewable energy methodologies. The decision impacts about 236 million credits, or 32% of the market. This development could deal a significant blow to a market that has already shrunk by nearly a quarter since its 2022 peak. However, it also signals ongoing efforts to reform carbon offsetting, a practice frequently criticized for potentially facilitating greenwashing

The Numbers

The Nuance

For several years, Japan’s central bank had been gradually scaling down the developed world’s most aggressive monetary stimulus. The process has been deliberately slow and often shrouded in confusion to obscure its true intentions. With the way it behaved, the Bank of Japan appeared fully aware of former US Treasury Secretary Lawrence Summers’ warnings: Removing a peg from financial markets can be a moment fraught with danger. 

Looking at the actions it has taken, in March 2021 the BOJ announced it would let 10-year bond yields diverge by about 25 bps from its 0% target. The BOJ waited two years to double the range, finally scrapping the 0% target altogether in March this year in a deliberately slow manner. Touching on confusion, the BOJ’s previous governor Haruhiko Kuroda regularly dismissed his various tweaks to policy as watering down monetary easing, despite the nature of the central banks actions. The BOJ have also occasionally undertaken massive bond purchases to prevent any accumulation of one-way bets on higher yields. 

Since the arrival of current bank chief Kazuo Ueda in April this year, we’ve seen them throw out the playbook that was so closely followed by his predecessor. He has presented a more assertive approach, scrapping negative interest rates in March and hiking them further last week. In doing so, the BOJ presented a new stance to monetary policy, which unfortunately came just ahead of a weak US jobs report that sparked concerns over the health of the US economy.