Given the recent market volatility, we wanted to reach out with some brief commentary to help explain the current environment. As per usual, there are many causes to any dramatic market movement (both up and down). We will do our best to highlight a few of those causes currently impacting the market.
First and foremost, the market was likely overdue for a period of volatility. In short, the market had grown complacent. By many measures, 2024 has been one of the least volatile years on record. Volatility as measured by the VIX index was hovering near record lows. The market has been on a long run largely to the upside for some time, and the market rarely has such long, uninterrupted periods of low volatility. Investor sentiment was high, and the market has a way of “punishing” investors to cause as much pain as possible. In short, this type of pullback was overdue. We have often referenced a JP Morgan chart that shows the largest drawdown in any given calendar year. On AVERAGE, that peak to trough drawdown is a little over 14% in any given year. So, these types of pullbacks are entirely normal and expected.
Secondly, while it is hard to “time the market” based upon valuations and P/E (Price to Earnings) ratios, by many measures the market had been trading at elevated levels. According to many analyst estimates, the S&P 500 was trading at close to 23 times projected 2024 earnings and 21 times projected 2025 earnings. These are multiples above the historical 25-year average. When you factor in higher interest rates on “risk free investments” such as US Treasury bonds, higher stock market valuations are harder to support. While the market can trade at higher multiples for extended periods of time, those higher multiples give the market less margin for error if/when something goes wrong.
On that note, a big part of the recent selloff has been some weaker economic data over the past week. In particular, some recent unemployment reports point to some deterioration in the labor market. In addition, it appears the consumer might finally be showing some signs of weakness. We want to emphasize these reports can be volatile and no clear-cut trend has emerged. Given the market was largely “priced to perfection” per our analysis above, any signs the economy could be in for a “Hard Landing” are not well received. We would encourage you to watch our most recent quarterly webinar we released BEFORE this bout of volatility that highlighted some signs of economic weakness we were monitoring (link included below).
Lastly, and most technically, there is something in financial markets known as the “Yen Carry Trade”. While the concept is very technical in nature, it basically involves institutional investors (primarily hedge funds) being able to borrow in Japanese Yen, which for decades have had rock-bottom interest rates, and then investing those proceeds in higher yielding investments like U.S. Government bonds. In theory, this appears on the surface to be “free money”. But as you would expect, in finance nothing is that simple. Over the past several weeks, the Bank of Japan has raised their interest rates, making their currency appreciate. At the same time, as the Fed has forecast their intention to cut interest rates later this year, US interest rates and the dollar have depreciated. This can lead to large losses quickly in the “Yen Carry Trade”, and has resulted in the “unwinding” of many of those trades which involve selling risk assets(including US Stocks). Again, that is a very basic explanation of a very complex topic, but it is undoubtedly leading to a “risk off” environment in financial markets.
In summary, if you take a market with very optimistic sentiment trading at fairly high valuation multiples, mix in some bad economic news coupled with the unwinding of one of the most profitable financial strategies of the past couple decades, you get the last few days. When you add in some heightened geopolitical volatility (ratcheting tensions in the Middle East and a monumental US election season), it is probably only surprising this didn’t happen sooner.
All that being said, regardless of the cause(s), these types of volatility are normal and expected. The S&P 500 is still up about 8% for the year. More importantly, as financial professionals we plan for and account for these types of bouts of volatility. We admittedly are no better at predicting the short-term direction of the market as anyone else (and no one is good at it), but we do have a fair understanding of volatility in markets and the idea of how long-term capital appreciation is achieved; being willing to ride through common periods of market dislocation.
We recognize these periods of volatility can be unsettling, so please don’t hesitate to reach out to a FAS advisor to discuss any concerns or visit about your longer-term financial goals. While these periods of market gyrations are never fun to experience, they are the necessary price of admission to longer term gains, and thankfully as a firm we have experienced many of these. We will be here to guide you through this one to the best of our ability, as we have in the past. Thank you for your continued confidence in our organization.
Click here to view our important disclosures.
FAS Market Update August 2024
Given the recent market volatility, we wanted to reach out with some brief commentary to help explain the current environment. As per usual, there are many causes to any dramatic market movement (both up and down). We will do our best to highlight a few of those causes currently impacting the market.
First and foremost, the market was likely overdue for a period of volatility. In short, the market had grown complacent. By many measures, 2024 has been one of the least volatile years on record. Volatility as measured by the VIX index was hovering near record lows. The market has been on a long run largely to the upside for some time, and the market rarely has such long, uninterrupted periods of low volatility. Investor sentiment was high, and the market has a way of “punishing” investors to cause as much pain as possible. In short, this type of pullback was overdue. We have often referenced a JP Morgan chart that shows the largest drawdown in any given calendar year. On AVERAGE, that peak to trough drawdown is a little over 14% in any given year. So, these types of pullbacks are entirely normal and expected.
Secondly, while it is hard to “time the market” based upon valuations and P/E (Price to Earnings) ratios, by many measures the market had been trading at elevated levels. According to many analyst estimates, the S&P 500 was trading at close to 23 times projected 2024 earnings and 21 times projected 2025 earnings. These are multiples above the historical 25-year average. When you factor in higher interest rates on “risk free investments” such as US Treasury bonds, higher stock market valuations are harder to support. While the market can trade at higher multiples for extended periods of time, those higher multiples give the market less margin for error if/when something goes wrong.
On that note, a big part of the recent selloff has been some weaker economic data over the past week. In particular, some recent unemployment reports point to some deterioration in the labor market. In addition, it appears the consumer might finally be showing some signs of weakness. We want to emphasize these reports can be volatile and no clear-cut trend has emerged. Given the market was largely “priced to perfection” per our analysis above, any signs the economy could be in for a “Hard Landing” are not well received. We would encourage you to watch our most recent quarterly webinar we released BEFORE this bout of volatility that highlighted some signs of economic weakness we were monitoring (link included below).
Lastly, and most technically, there is something in financial markets known as the “Yen Carry Trade”. While the concept is very technical in nature, it basically involves institutional investors (primarily hedge funds) being able to borrow in Japanese Yen, which for decades have had rock-bottom interest rates, and then investing those proceeds in higher yielding investments like U.S. Government bonds. In theory, this appears on the surface to be “free money”. But as you would expect, in finance nothing is that simple. Over the past several weeks, the Bank of Japan has raised their interest rates, making their currency appreciate. At the same time, as the Fed has forecast their intention to cut interest rates later this year, US interest rates and the dollar have depreciated. This can lead to large losses quickly in the “Yen Carry Trade”, and has resulted in the “unwinding” of many of those trades which involve selling risk assets(including US Stocks). Again, that is a very basic explanation of a very complex topic, but it is undoubtedly leading to a “risk off” environment in financial markets.
In summary, if you take a market with very optimistic sentiment trading at fairly high valuation multiples, mix in some bad economic news coupled with the unwinding of one of the most profitable financial strategies of the past couple decades, you get the last few days. When you add in some heightened geopolitical volatility (ratcheting tensions in the Middle East and a monumental US election season), it is probably only surprising this didn’t happen sooner.
All that being said, regardless of the cause(s), these types of volatility are normal and expected. The S&P 500 is still up about 8% for the year. More importantly, as financial professionals we plan for and account for these types of bouts of volatility. We admittedly are no better at predicting the short-term direction of the market as anyone else (and no one is good at it), but we do have a fair understanding of volatility in markets and the idea of how long-term capital appreciation is achieved; being willing to ride through common periods of market dislocation.
We recognize these periods of volatility can be unsettling, so please don’t hesitate to reach out to a FAS advisor to discuss any concerns or visit about your longer-term financial goals. While these periods of market gyrations are never fun to experience, they are the necessary price of admission to longer term gains, and thankfully as a firm we have experienced many of these. We will be here to guide you through this one to the best of our ability, as we have in the past. Thank you for your continued confidence in our organization.
Click here to view our important disclosures.
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