This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.
We also provide regular webinars called “Making Sense of Markets” where they discuss the factors affecting economies and markets. Our latest webinar was on 7th August. Please click here to watch.
In this latest market update we discuss what has happened in global markets and the reasons behind this.
The past week has witnessed a surge in volatility across investment markets. Heavy declines occurred on Monday, 5th August, followed by subsequent recoveries. Japanese equity markets experienced the largest swings, with a 12% loss on Monday and then a 10% recovery on Tuesday. Smaller, yet still notable movements also occurred in US, European and UK markets throughout the week, each falling on Monday and then staging volatile recoveries. At the time of writing on Friday, 9th August, these markets have returned to approximately the same levels as last Friday.
The turbulence can be attributed to a combination of three factors: growing negativity surrounding high valuations in the US tech sector, a disappointing data release for the US labour market on August 2nd, and a flight of capital from Japanese markets due to differing interest rate policies.
The Shine is Coming Off
We are currently in the middle of earnings season, with listed US stocks releasing their quarterly financial results. Technology companies, and especially those which benefit from the AI revolution have experienced extremely strong profits and earnings growth over the past year. Investors have been rewarding these with high share prices However, as highlighted in previous market updates, the sustainability of these valuations has been questionable in many cases and in this latest crop of results, more imperfections are starting to show. For instance, Amazon’s quarterly results indicate that their substantial capital expenditure on AI capabilities has not yet translated into enhanced revenues, leading to shrinking profit margins and a significant drop in Amazon’s share price.
Similar stories can also be told for many of the largest technology companies and it has contributed to the trend of underperformance for the sector which started in early July. This has therefore created an attitude of concern amongst investment markets which was further exacerbated over the past weekend.
A Disappointing Employment Number
During the previous week, the Bank of England cut interest rates for the first time in this cycle (from 5.25% to 5%). In contrast, the US Federal Reserve chose to keep interest rates steady. Initially, markets accepted this decision, understanding that the strong US economy justified waiting until September for the first rate cut. However, this acceptance gave way to a feeling that the Fed was mistaken in its cautious approach. The monthly non-farm payrolls employment results released on that Friday showed a significant slowdown in job creation relative to the previous month’s data. Although still positive, the data fell far below expectations, raising concerns that the US economy may be slowing more than anticipated.
Interest Rates Diverging
Meanwhile, across the Pacific, the Bank of Japan raised interest rates during the same week, continuing its trend of tighter monetary policy following success in achieving much-wanted inflation in the economy. Higher interest rates in Japan and the expectation of lower rates in the US led to the appreciation of the yen against the dollar, which then resulted in falls in Japanese stocks.
Each of these three stories would have created notable market movements in their own right, but given they all occurred simultaneously, they started to feed off each other, resulting in panic over the weekend and delivering large losses.
As mentioned, nerves eased on Tuesday, 6th August, and recoveries have been mostly experienced. Concerns are valid over a slowing US economy, but the wild movements appear an overreaction from which investors have since calmed.
A Lack of Liquidity
The direction markets go from here in the short term is uncertain. Further economic data releases from the US over the coming weeks will shed more light on the state of the US economy, but volatility is likely to stay high. This is especially the case during the summer holiday period when fewer market participants are active, resulting in fewer trades being placed. Lower trading volume means liquidity is thinner than at other times of the year, which can lead to higher-than-usual swings in performance. This factor likely contributed to the large market swings of recent days.
Bonds, Doing Their Job
What was encouraging during this episode was the performance of bond markets. In general, bonds are typically considered as a ‘defensive’ asset class, often rallying at times when equities are falling. While, over the long term this is usually accurate, over recent years it hasn’t always been the case. Following years of strong performance, bond prices were very high in 2020 and 2021 and correspondingly, yields were low. Therefore, when in 2022 equity markets fell heavily due to inflation becoming problematic, bonds also sold off, with few defensive qualities on show.
Now, however, with bond prices back at more sustainable levels, and yields more attractive, bonds are better positioned to provide appropriate diversification. During the recent heavy equity market falls, bonds grew in value, helping clients with multi-asset portfolios offset some of the losses stemming from equity allocations. While this is a side note to the main story of recent days, it serves as a positive reminder of the benefits of diversification in investment portfolios.
Our Philosophy
Volatility is a part of investing which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fair better in different market conditions as they are more defensive assets such as bonds, whereas during periods of growth equities tend to fair better.
Armstrong Watson, in addition to our full range of accountancy services, also have our own fund management expertise from the Future Money asset management team, as well as independent expertise from the wider market. We are able to use this to help provide insight, commentary, advice and support to our financial planning and wealth management clients.
A key aspect of our investment philosophy is that it is time in the market not timing the market, which is usually the best approach. For more information and guidance on Investing, please download our useful Guide to Investing here.
At Armstrong Watson, our quest is to help our clients achieve prosperity, a secure future and peace of mind. We believe that for those people who are considering taking financial advice in relation to their savings and investments it may be a good time to do so to utilise existing allowances and tax reliefs due to the fact that certain allowances are frozen to 2025/26.
Important Information
Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested.
If you would like to discuss your investment portfolio please speak with one of our Financial Planning Consultants on 0808 144 5575 or email us.
