Market Update: Interpreting Recent Declines

U.S. equity markets pushed to new highs as recently as a few weeks ago, inspired by data that showed the U.S. economy grew at a 2.8% rate in the last quarter and anticipation that the Federal Reserve was about to begin taking their foot off the economic brakes by cutting interest rates in their September meeting. The consensus was that we had avoided a “hard landing” economic scenario, with expectations of either a soft landing or no landing at all.

However, a series of weak jobs reports has cast doubt on this view. There’s a growing narrative that the Fed is “late” in its actions and that the economy is on weaker footing than previously thought. This has triggered a global sell-off in risk assets, with significant selling pressure in big tech and Japanese markets. Interest rates have moved lower as traders speculate that the Fed will need to cut rates more aggressively. Broad U.S. equities are still positive for the year but are down about 6% from their mid-July peaks with additional losses looking likely for Monday’s session. The Nasdaq is down closer to 10% and experiencing selling pressure.

Overreaction to Job Data?

Monthly jobs data is notoriously fickle and frequently revised over time. There is a trend indicating that economic strength is easing, which should not be surprising given the Fed’s restrictive stance in its fight against inflation. The unemployment rate has come off its historic lows and is creeping higher, which was always to be expected given that much of the inflation feedback loop was being driven by spiraling wages.

Beyond the Headlines: Other Influences

And as is always the case, the short-term narrative is also being influenced by geo-political and idiosyncratic events:

Middle East Tensions: The Middle East seems poised to erupt into a wider conflict—and while this involves a terrible human tragedy—these events have historically not caused an outsized impact on global economic growth. Even an oil price shock can be better managed in the modern era of U.S. energy production.
Warren Buffett’s Apple Stake Sale: Warren Buffett’s disclosure that he sold half of his stake in Apple spooked folks, even though he did this over a month ago when the market was at all-time highs and not in reaction to this recent downturn or jobs data.
Political Divisiveness: And last but not least, political divisiveness and the potential for election volatility is quickly coming around the corner.

Healthy Corrections and Investor Behavior

While the growing list of global concerns may feel omnipresent, it’s not surprising that investors are taking profits and repositioning from the strong “risk on” posture seen in the past 18 months.

And truth be told, this is a signal of health. They say a “good market climbs a wall of worry,” so a market that self-corrects and reintroduces some skepticism is on better footing than one that gets overwhelmed with optimism. However, it’s essential not to underestimate this selloff or any correction. Market declines can be reinforcing, causing more esoteric exposures to “break.”

It would seem the declines in Japan would fit into this category as a confluence of factors created a bit of a squeeze and led to some forced selling and a single-day decline in the Japanese stock market of over 12%. And as broader markets decline, there is a feedback loop that creates a “wealth effect” where consumers slow their consumption based on the losses appearing on their investment statements. This can self-inflict a reduction in economic growth and ultimately profits, which in turn gets priced into stock and bond markets.

Diversification at Work

While market declines are not to be underestimated, they’re ultimately to be expected. Intra-year market declines average 14% in any one year. And they’re irrelevant in the long run, other than perhaps presenting us the ability to rebalance to buy some stock at cheaper prices. If the declines continue, our trading algorithms will trigger us to do some buying, although given the gains of the past few years we’ve got some room to go before we hit our purchase thresholds. And fortunately, unlike 2022, portfolio values are getting help from the bond/diversifying side of the portfolio as we’ve picked up a few percent with falling interest rates. This is the benefit of diversification, which by its very nature means you won’t always have all your money in the best-performing asset class, but you consequently won’t have it all in the worst when things get bumpy.

Staying the Course: Long-term Optimism

Our investment strategy is founded on a very simple, predictable premise that “capitalism works” and the global economy creates profit for patient investors who are rewarded for shouldering market risks. We don’t think this has changed despite a few jobs reports or an uncertain near-term interest rate policy. And in our view, there is quite a bit to be optimistic about going forward, including the continuing AI demand cycle and the prospect of lower long-term interest rates and its impact on housing and small business financing. But that’s for a future letter when we can take a wider view at the overall State of the Union.

As always, we appreciate your trust as stewards of your finances. We welcome personal conversations via phone, Zoom, or in-office meetings.