An eventful August

As we begin waving goodbye to the summer, August’s data bookends have been  somewhat eventful. The month opened with the market digesting some less-than-inspiring economic data. Alongside a surprise interest rate increase by the Bank of Japan (announced with an unusual hawkish tone by Governor Ueda), figures were published indicating the US economy created far fewer jobs than anticipated, while unemployment rose to its highest level in three years. A side-effect of the new information was to trigger what is known as the “Sahm Rule”, a historically strong indicator of imminent recession. The market’s knee-jerk reaction to weaker data was reminiscent of a toddler’s temper-tantrum: Japan had its worst one-day fall since the 1987 Crash, the US since September 2022, while the FTSE100 fell by 5% in 3 days.

Recovery and bond rally

I did feel that was overdone, and that quickly proved to be the case as the grown-ups recognised that the steady weakening of the US jobs market has set a trend over several months in any case, while the accelerated fall in the July employment numbers was exacerbated by temporary lay-offs in Texas following the impact (literally) of Hurricane Beryl. Furthermore, economist Claudia Sahm, the inventor of the eponymous rule, suggested that the postpandemic period might be so unusual as to render the rule ‘broken’. We shall see.

On the bright side, bonds rallied, thus mitigating some of the equity devaluations for low- and medium-risk portfolios; these indications of a slowing US economy have significantly increased the likelihood and incidence of interest rate cuts starting this month, and data over the next few weeks is likely to reinforce that view.

Market rebounds, but volatility remains

As the month progressed, markets rebounded to a large extent, with the US and UK markets up 2.4% and 0.5% respectively in local currency terms, and Japan only 2.9% lower despite being down 20% in the first week.

Global bonds gained 2.5%. However, all overseas holdings’ performances were depressed somewhat by a soaring Pound; a dollar of profit now buys only 76.2p in sterling versus 78.7p at the end of the first week in August.

As we enter September, we are set to be assailed by yet more economic data, and indeed the month has started rather as August did, with markets’ nerves tested by more apparent cracks in the US economy being exposed. Technology stocks suffered steep falls as the market opened following the US holiday (in which America rejoices in its inability to spell ‘labour’ properly).

The index of computer chip manufacturers fell by almost 8%, while AI chip inventor Nvidia plummeted by virtually 12%, equivalent to $280bn, and now some 16% lower than it was at the start of July.

It is still up 118% in 2024, however. It is worth pointing out Avellemy’s portfolios have been underweight Nvidia since early June, the team preferring to diversify away somewhat from high-growth US companies.

Explaining market volatility and outlook

The media is already attempting to ‘explain’ these bouts of market volatility, one suggested culprit being a sentiment survey that suggests manufacturing in the US has now been contracting for five months. However, factory activity is still higher than it was at the start of the year, so rationally this information shouldn’t change our opinion of a company’s value. Sentiment surveys are subjective by definition, so should therefore carry much less significance than official government data.

Frankly, there are no obvious culprits. The conflicts in Ukraine and the Middle East are having little effect – the oil price is down on the month, at its lowest point this year and near its low post-Ukraine invasion. Equity money hasn’t diverted to Gold – the price is where it was in mid-August and has fallen slightly recently. Small and medium-sized companies’ share prices are not accelerating, so there is no evidence of a rotation out of large companies. Companies and sectors that have done well are always prone to bouts of profit-taking, and ‘bad’ news is often simply a catalyst for that. Some investors take profits for no other reason than others seem to be doing it, and they don’t want to miss out.

All of this demonstrates the benefits of diversification. A lower or medium-risk investor will probably have seen their portfolio valuation a little higher at the end of August than at the start, due to the positive impact of their cash and bond exposures; an Avellemy Risk Level 5 portfolio is up almost 9% over the year to 31st August.

As for expectations, I will be surprised and disappointed if our next monthly commentary does not report a US interest rate cut of up to 0.5%, even if inflation has not reached the magic 2% number. There are more jobs reports published shortly after this commentary goes to press and any further loss of economic momentum will underline the need to loosen monetary policy to mitigate the risk of recession.

Conclusion

As I write, the US ‘yield curve’ is no longer inverted, ie 10-year yields are higher than 2-year for the first time in over 2 years. Rationally this should be the case – lending over 10 years involves more risk than over 2 years. However, in the past a return from inversion has been a strong signal of recession, and closer inspection reveals that the 2-year rate is lower than the base rate – a mini-inversion if you will. Again, all this signals a need to cut imminently, and over several Fed meetings through 2025, with perhaps a base rate target of 3%, from the current 5.25%.

See you next month, as we welcome Autumn.

Graham Bentley

Chief Investment Officer

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