Understanding Recent Market Volatility

We are currently navigating a period of heightened market volatility, where the factors driving investor anxiety are as dynamic as the markets themselves. In this briefing note, we will examine three primary contributors to the recent sell-off, providing a clear understanding of the forces at play and their impact on markets.  

Changing attitudes to interest rate movements

 Recent shifts in global monetary policy have sent shockwaves through the financial markets, in part causing significant volatility and raising concerns about economic slowdowns. The interconnected nature of the global economy means that changes in one region can have far-reaching impacts, as evidenced by recent events in Asia, the UK, and the US.

In Japan, the central bank's decision to raise interest rates from 0.1% to 0.25% might appear modest, but it was one of the core catalysts which triggered the largest two-day drop in the Japanese stock market's history. This decline erased gains accumulated over the past year during which Japan had been a favourite among investors. The reason for this is that the Yen has strengthened significantly against the US Dollar from its June lows as a result of the rate hike, which will hurt the price competitiveness of Japan's dominant export sector and has impacted investors borrowing in Yen – the so-called carry trade. Nevertheless, earnings and the wider business environment in Japan are still fundamentally strong.

By contrast, in the UK, the central bank lowered the base rate by 0.25%, bringing it down to 5%. This decision followed consistent monthly data showing inflation around the target level of 2%. Despite this seemingly positive move, the UK's main stock market fell by about 1% on the day of the rate cut, with financials being the worst affected sector. This development, mirrored in Europe, is contrarian in comparison to the developments in Japan.

Moreover, it has been a generally held belief amongst investors that declining rates makes capital cheaper for borrowers, stimulating economic activity and therefore spurring equity markets on. However, the current context suggests these cuts are now being taken as an advanced warning of economic slowdowns, rather than a boost, and markets have been sounding a rather dramatic retreat in the past few days as a result.

Concerns for technology companies

Weaker-than-expected quarterly earnings for most of the USA’s much-vaunted tech sector have exacerbated fears of economic instability. The "Magnificent 7" tech giants collectively lost $1 trillion in market capitalisation in a single day, a stark indicator of market distress, and the USA’s core market opened 4% lower on Monday 5th August - a rout by anyone’s standards. Futures markets now price in a 60% chance of an emergency Federal Reserve rate cut, implying widespread concern about the outlook for the economy. There is growing anxiety that the Federal Reserve’s widely anticipated first rate cut in September may come too late to avert recession.

This turmoil has wiped out this year’s gains in major Asian stock markets in a single day, driven by weak US data that has alarmed global investors. These investors, who hold significant stakes in Asia’s chipmakers due to the AI boom, are reacting to recession fears, leading to unprecedented volatility. South Korea’s and Taiwan’s market indices experienced record declines, with the sell-off in chipmaker stocks highlighting the severe impact of US economic distress on global markets. Markets in the UK and Europe have also suffered severe blows for the same reason and they never move in straight lines!

Geopolitical concerns

The sentiment of investors toward the broader macroeconomic outlook appears increasingly bleak. As if they were not already juggling enough concerns, the latest upheaval in the Middle East has only added to the anxiety. A recent missile attack from Hezbollah in Lebanon struck Israeli civilians, pushing regional tensions to their highest level in years. In response, Western nations like the US and UK have advised their citizens to leave the area.

Israel retaliated with a series of targeted strikes against top Hamas and Hezbollah officials in both Tehran and Beirut, prompting Iran to issue threats of further action. In a show of support for Israel, the US has deployed additional aircraft and positioned its navy’s Sixth Fleet for potential assistance. As the situation teeters on the edge of further escalation, diplomatic efforts are underway to cool the rising heat and push back the prospect of all-out war. Given the importance of the shipping lanes in the region to global trade, the potential ramifications for investors could be significant.

Staying the long-term course

In the face of fluctuating interest rates, a shifting global economic outlook, and increasing geopolitical instability, investors are navigating a particularly challenging landscape. However, focusing on longer-term fundamentals and not panicking is crucial when it comes to meeting your investment objectives. Given the heightened market volatility, maintaining a diversified portfolio across different asset classes, regions, and investment styles is crucial. By avoiding overconcentration in any single trend, we can reduce volatility and manage risk more effectively. Diversification allows us to benefit from the fact that various asset classes and regions perform differently at different times. By balancing these elements within the portfolio, we aim to smooth out the ride and enhance long-term returns.

We remain vigilant and will update you as these stories evolve.