1. Global equity markets sold off in early August but recovered by month end.
This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), EEM (iShares MSCI Emerging Markets ETF in orange), and EWJ (iShares MSCI Japan ETF in dotted red).
The primary impetus for the rapid sell-off in global equities seemed to be fears of a Japan Yen carry trade unwind after comments by the Bank of Japan (BOJ) about more increases in its policy rate. The BOJ raised its policy rate to 0.25% on July 31. When the BOJ walked back its hawkish comments, equity markets began to recover.
The incident highlights the current high sensitivity of risky asset prices to reductions in financial leverage by levered investors.
2. Below the surface, dividend payers outperformed for second month in a row. Low volatility stocks led the way in August. These occurrences point to a market rotation away from risk and toward more stable stocks, especially those that are interest rate sensitive.
Source: S&P Dow Jones Indices
Source: S&P Dow Jones Indices
Momentum and growth stocks, especially the so-called Magnificent Seven mega cap stocks, have delivered historically strong performance since mid-2023. The question is whether recent equity market activity marks a broadening of performance and a catch-up by the lagging sectors and factors or proverbial canary in the coal mine, Equity market performance in the first several days of September, after the bout of volatility in early August, hints at burgeoning equity market weakness after a surge in stock prices over the last 22 months.
Source: S&P Dow Jones Indices
3. The good news is the behavior of high yield credit spreads. After jumping 90 basis points from their July lows, high yield spreads reversed course, declining once again to well below their long-term average.
High yield credit spreads were trending downward over the last year until the bout of volatility in early August.
High yield credit spreads remain well below levels that signal a brewing recession or financial crisis.
4. Markets are now pricing in several federal funds rate cuts by the Federal Reserve. Since May month end, the two-year Treasury yield has declined by 100 basis points.
5. Inflationary pressures are starting to ease. Inflation remains a headwind for investors seeking high real returns (real return = nominal return - rate of inflation).
In the U.S., the headline inflation rate had plateaued over 1% above pre-pandemic levels. In the last three months it has started to creep down.
The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.
Due to sticky inflation, the FOMC has kept the effective federal funds rate at 5.33% for the past year.
We discussed the inflation challenge in more detail in April’s market update.
6. While inflationary pressures are easing, economic growth is also slowing down. The recent earnings reports from the dollar stores point to economic challenges facing lower income consumers.
This chart shows the performance of various consumer related stocks in August 2024.
WMT (Walmart Inc. in orange), COST (Costco Wholesale Corp. in yellow), ROST (Ross Stores, Inc. in green), TJX (The TJX Companies, Inc. in red), MSCI Emerging Markets ETF in orange), DLTR (Dollar Tree, Inc. in purple) and DG (Dollar General Corporation in blue).
In August, both Dollar General and Dollar Tree reported disappointing revenue growth and forecast weak volume growth going forward. While the stock prices of other consumer related stocks (consumer staples and off price) benefited from the market rotation, the dollar store stocks were crushed by pull back in purchases by lower income consumers. If a recession is brewing, the lower income consumer will likely be a canary in the proverbial coal mine.