Market Gyrations

Recent Market Fluctuations

The S&P 500, our preferred market reference, hit its last peak on July 16, 2024, at 5,667.20. Since then, it has been on a steady decline, and on August 1, it took a more substantial downward turn. In the following days, it continued to decline until August 5. The complete pullback from July 16 to August 5 was -8.4%. It was a very noticeable move in a short amount of time. Since August 5, the market has recovered a bit, but why did the market move so dramatically?  Let’s take a look.

What Caused The Market Gyrations?

Our starting place is to look at inflation in the U.S. June’s 12-month inflation rate came in at +3.0%, which is higher than the Federal Reserve’s (Fed) target of +2.0% but is a nice decline from the May inflation rate at +3.3% and April inflation at +3.4%. Lower inflation is an indicator that the economy is slowing. A slowing economy might linger in your mind, but that inflation report came out on July 11, so it wasn’t the primary driver of the markets.

Next, we look at Gross Domestic Product (GDP), which in Q1 2024 was at +1.4%, a somewhat disappointing level, but Q2 2024 rebounded a bit to +2.8%, which is not spectacular, but at least reasonable. So, GDP is not great, but likely not the primary driver of the market gyrations.

Our next important data point is the July U.S. Employment report, which came out on August 2, 2024. In that report, employers added just 114,000 jobs, and the unemployment rate rose to 4.3%. Now, 4.3% is not necessarily a bad level and does not indicate imminent recession, but it, along with an unimpressive level of hiring for the month, is a cause of concern. We believe this was a trigger.

Is The Risk Of Recession Rising?

We have been saying for over a month that we believe the risk of recession is rising. High interest rates are in place now and are designed to slow the economy and bring inflation down. Everyone knows that. However, how long you keep rates high is unknown. Inflation has improved but is still not down to the +2.0% Fed target. So, do you keep rates high or start reducing interest rates to prevent the economy from slowing down enough to generate a recession?  That’s the challenge the Fed is facing.

We believe the Federal Reserve may have already kept interest rates too high for too long and could see a recession in early 2025. However, the Fed is signaling a possible rate reduction in September, which might be enough to prevent a recession. We are not predicting a recession but believe the risks have increased. Our logic, and we think our logic is in alignment with recent market sentiment, is that inflation is improving, and the economy is slowing. Plus, we have a less-than-great level of GDP, and recent employment reports suggest that the slowing economy is starting to affect significant areas of economic activity. We believe the market started seeing and realizing precisely this on August 1 and then was reinforced with the August 2 employment report.

What Does It All Mean?

We think the market will recover to some degree in the coming weeks. It is not unusual for the markets to come to a conclusion and then overreact in the short term. Given all the automatic trading models and trading algorithms operating on the S&P 500, it’s not surprising that market selling can be carried away.

Another factor in the market gyrations is that the Bank of Japan (Japan’s Central Bank) increased its interest rate recently and started a market selling process due to previous trades called “interest carry.” Interest carry trades are associated with Japan having a very low interest rate and investing in countries (like the United States) with higher interest rates. When Japanese rates increase, that interest carry no longer works, and undoing it entails high levels of market selling. It possibly triggered some of what we saw in early August. 

It is also possible that the markets ignored some of these economic slowing signals and bid the S&P 500 up beyond full value in mid-July. We think a reasonable S&P 500 level is about 5,500, higher than where we are now but below the high seen in July.

We will continue to watch the markets and corresponding economic data, and the Fed’s actions to better determine our future direction. But, in the end, we don’t think this is the start of something bad. We are not in a recession now and may not be for some time.

All the best,