Investment Update: September 2024

INVESTMENT UPDATE SEPTEMBER

*All return in local currency terms

Overview

Looking at the table above, one could be forgiven for concluding that August was a fairly benign month for markets. However, the start and end figures disguise what was quite a volatile month, for both stock markets and currencies alike. It was also a useful reminder about why we do not rush to react to significant market moves when they occur or attempt to time markets. For several factors discussed in the following update, we saw the most significant one-day fall in the Japanese stock market since the 1950’s, we saw the former darling of the US market, Nvidia, fall 15%, before recovering, and the US dollar decline by over 2%. Volatility levels spiked to those last seen in the early days of the COVID pandemic. We saw similar volatility in Europe. However, markets soon regained their composure and, as the returns show, the declines were short lived, although the fall in the dollar did dampen the returns from the US.

Once of the catalysts for these moves was caused by a sudden surge in the value of the Japanese yen, following a surprise interest rate increase from the Bank of Japan (BOJ). This had an impact on the so-called Carry Trade*, which in turn caused ripples across other asset classes. However, soothing noise from the BOJ about the importance of maintaining stability assuaged fears that further such surprises were unlikely.

Other than the resilience of equity markets, a very encouraging development was the behaviour of bond markets during the short period of equity market volatility. Historically, bonds were seen as a dampener of risk in portfolios i.e. being stable when equities were struggling, but since 2022 this characteristic has been challenged by the rapid increase in inflation and interest rates. However, during August we saw bond markets reprise their ‘safe haven’ status in times of uncertainty, rising as equities fell.

*The Carry Trade is where you borrow money in the currency of a country where interest rates are low and invest it elsewhere for a better return e.g. the US, where interest rates are around 5% versus Japan’s rates of less than 0.5%. However, this ‘low risk’ trade was adversely affected when the unexpected rise in Japanese interest rates caused the yen to suddenly surge against the dollar, which worked against borrowers of yen. To cover losses, traders may have had to liquidate positions in the yen or other asset classes, further contributing to downward pressure on prices.

US

The US economy was certainly at the forefront of investors’ minds during August, as attention turned from inflation to growth. We saw inflation numbers continue to move closer the US Federal Reserve (Fed)’s 2% target, however, significantly revised jobless numbers seemed to indicate that there is now a risk of the US economy slowing down and slipping into recession. The timing of this coincided with the sudden rise in the yen and caused US markets to fall quickly early in the month. However, conciliatory noises from the Fed over the direction of interest rates and stabilisation of the yen, allowed the main market to rebound significantly, ending the month in positive territory.

This recovery was further assisted by comments by Jerome Powell while at the central bankers’ symposium at Jackson Hole. He made it very clear the direction of travel for interest rates was down and that this would commence in September. Crucially, he also stated that the Fed ‘will do everything it can’ to make sure the labour market remains strong, given it was the latter that markets now seemed to be focussing on. On the sector front, we saw increased volatility in technology stocks, as investors worried that the AI led boom was running out of steam. The technology stock rich NASDAQ index, which had been leading returns this year, underperformed the main market. Mid-sized and small company-based indices also underperformed, as they are viewed as more susceptible to a slowdown in demand in the domestic economy. Meanwhile, we saw the US dollar continue to decline against a basket of currencies, in anticipation of rate cuts.

On the political front, we saw vice-president Harris’ polling advance in the US presidential election race, following a strong performance at the Democrats’ convention. At this stage, neither candidate has made any reference to addressing the burgeoning US budget deficit, which may be a key determinate in the US government bond market later this year.

Europe

Optimism over the prospect for further rate cuts, following a three-year low Eurozone inflation number of 2.2%, drove European markets higher, with the Dax reaching an all-time high towards the end of the month. Some might consider this a paradox, given the parlous state of the German economy, evidenced by VW announcing that they may close factories for the first time in their history. However, markets are always looking forward, so the prospect of lower rates may have had a positive influence, although the continued decline in oil prices also probably helped, given the German economy’s reliance on heavy manufacturing. France’s stock market continued to trade below its pre-election level, as President Macron wrestled with the problem of creating a coalition that stands a chance of functioning.

UK

Given its lack of exposure to technology stocks, the UK market held up relatively well during the bout of volatility early in the month. The economy seems in reasonable shape and we saw positive progress on the health of both the UK’s service and manufacturing sectors, with better than expected Purchasing Managers Index data (above 50 is a sign of positive growth).

Source: FT 22/08/2024

Inflation data seems to continue to support the Bank of England’s decision to cut interest rates. However, with above inflation wage increases in the public sector being signed off by the new government, wage inflation, which was already stickier than goods inflation, will no doubt be a significant factor for the Monetary Policy Committee to consider. Unsurprisingly, unions in sectors that were not recipients of these rises already seem emboldened to demand higher wages in the future. This is perhaps partly why the UK gilt market lagged the US and Europe during the month, and as Andrew Bailey remained ambiguous about the direction of interest cuts while at Jackson Hole. We await the October UK budget with interest, given the possibility of significant changes to capital taxes.

Japan

The aforementioned volatility generated by the strength of the yen, culminated with a double-digit downward spike in the Nikkei index in one day. Some of this can be attributed to the unwinding of complex trades around the yen, so market volatility quickly normalised after the Bank of Japan’s governor, Mr Yueda, made a statement saying that disorderly markets were not their goal. This seemed to suggest that they wouldn’t be springing surprise rate cuts on the market in the immediate future. Regardless, they will have to balance the desire to normalise inflation and interest rates while dealing with a slowing economy.

 Asia and Emerging Markets

The economic outlook for China remains poor. Retail sales, for instance, are 9% weaker than their pre-pandemic trend. The Chinese are ramping up exports from state-subsidised enterprises to compensate, and their inexpensive goods are causing disinflationary pressures in the west. The Chinese currency has weakened to assist exports but over capacity remains a problem with western tariffs creating headwinds to progress. Of course, the duo of structural problems remains unresolved, a burgeoning debt problem linked to a bankrupt property sector once responsible for as much as 25% of GDP and a shrinking and ageing population making economic expansion difficult, but simultaneously explaining heavy investment in technology and notably artificial intelligence. Further stimulus is undoubtedly required by the People’s Bank of China. America, Canada, Europe, and the UK are imposing trade tariffs on Chinese electric vehicle (EV) and solar imports, creating significant export challenges for China. In response to these tariffs, China may look to offload its surplus EV and solar inventory in Asia and Africa at lower costs. While short-term deflationary pressures may benefit consumers, there could be long-term economic implications. Elsewhere in Asia and Latin America, the weaker dollar provided a stimulus for those markets with higher levels of dollar denominated debt, producing decent levels of return on a local currency basis at least.

Outlook

Historically, September tends to be a negative month for stock markets, but there is the prospect of the first rate cut from the Fed mid-month. The extent of this cut, should it happen, will probably dictate the immediate direct of travel, as it does seem the markets are pricing in at least a quarter point cut at present. There is a potential negative impact from a weaker US dollar, but within the managed portfolios there is a partial hedge against this in place, which is already having a positive impact. There is also the prosect of further rate cuts elsewhere. The positioning of bonds in portfolios, useful for reducing volatility in portfolios, also gives us the prospect of further gains as a consequence. The liquidity backdrop remains favourable, but markets will no doubt be keeping a close eye on developments in the US presidential election race, as we move towards November.

Rockhold Asset Management, with contribution from Alpha Beta Partners, Marlborough and LGT, September 2024