Global equity markets have recently retraced some of their year-to-date gains, while government bond yields have fallen as investors gravitated to the safety of high-quality bonds. Today, we address what has driven this latest round of market unease.
Several factors have contributed to the recent weakness in equity markets. In the U.S., the S&P 500 began its retreat in mid-July as earnings reports from the tech giants were less well received than usual. Management teams’ commentary left investors wanting more clarity on when the companies’ substantial spending on artificial intelligence would yield returns. Then, following the U.S. Federal Reserve’s decision to hold its policy rate unchanged on July 31st, disappointing jobs and manufacturing data renewed investors’ concern regarding the U.S. economy’s ability to achieve a soft landing.
However, these weak reports were balanced with other better-than-expected data releases on the services sector, which makes up roughly three-quarters of the U.S. economy. Meanwhile, U.S. GDP grew at a solid 2.8% annualized pace in the second quarter, consumer spending remained robust, and productivity growth exceeded expectations at a 2.3% annualized rate. While we will keep a close watch on upcoming labour market data for deteriorating trends, we continue to see a resilient, albeit slowing, U.S. economy.
What else is contributing to market volatility? Likely, the actions of investors with objectives different from yours. Two popular trades this year, particularly among hedge funds, have included buying large-cap tech stocks and positioning for declines in the Japanese yen. These were profitable trades until mid-July when performance trends began to favour non-tech segments of the equity market. Around the same time, the yen started to appreciate as markets priced in rate hikes from the Bank of Japan, which materialized at the end of July. As market conditions changed abruptly, the unwinding of these trades by hedge funds and other investors, some of which were funded with borrowed money, amplified volatility and contributed to the speed and magnitude of price movements across financial markets in recent weeks.
Despite the recent turbulence, the U.S. large-cap stock market remains up roughly 12% year-to-date on a total return basis (including dividends), while the Canadian stock market is up around 8%. These are respectable gains, even if no further progress is made.
Following particularly subdued levels of volatility in the first half of the year, we believe it is reasonable to expect higher volatility through the remainder of the year. There may be some optimism around the U.S. central bank beginning to cut rates, as it is widely expected to do so in September, but we also caution that rate reductions, like hikes, take time to work their way through the economy. That does not mean we should remain passive as investors. Instead, market turbulence can present opportunities to review and rebalance holdings, ensure portfolios are well-diversified, and to initiate or add to positions in securities where valuations have improved. As always, we remain focused on ensuring our clients’ investments are on track to meet their long-term objectives, recognizing that maintaining discipline during periods of market instability is an essential part of successful investing.
Thanks for tuning in and see you in two weeks.