August – “It is time”
More fear than harm in August, as we witnessed one of the most dramatic sell off in stocks in years, with the S&P 500 losing over 7% over 2 trading days. All major indices took a hit due to a combination of factors. It all started with weak job and manufacturing data, and fear that the Fed may have delayed cutting rates for too long and the resulting increased probability of a recession. Meanwhile, the bank of Japan took everyone by surprise by increasing interest rates, leading to the unwinding of yen carry trade (borrow yen at a low interest rate, buy USD, invest the USD in bonds or stocks), thereby taking the volatility index (VIX) to a 4-year high.
All this was followed by a swift recovery, with most indices closing the month higher. We’ve mentioned it a couple of times in our monthly letters already, but this is another example of just how important it is to remain invested and not succumb to panic sales.
Data source : Bloomberg
August was rich in news for the US. GDP growth for the first half of 2024 came out at 2.8%, significantly higher than expected. Inflation, as measured by the CPI, finally reached below the 3% mark (2.9%) and the job market showed signs of cooling down. Three of the most looked at job-related figures most looked at are open jobs, wage growth and unemployment. The former 2 are beginning to decrease, while the latter is showing upward tendencies. Then came the speech of Fed President Powell, which we summarized in the title. Looking deeper into it, we can get the sense that the Fed is starting to shift its focus from price stability to stabilizing employment at current levels, both being part of their mandate. We believe that the first rate cut will be announced in September, and that there will be no further cuts before the elections, and depending on new figures, perhaps 1-2 rate cuts in December. We believe the number of rate cuts being priced by the market (i.e. 5 rate cuts leading to a 1.25% reduction) to be too aggressive. The Purchasing Managers' Index is still in expansion territory, but points to a two-speed economy, with services carrying manufacturing, as it has for the past 2 years.
Europe was just as volatile earlier this month, simply from a spillover effect. PMIs are in expansion territory as well, and suffer from the same disparity between services and manufacturing. On the other hand, the job market is slightly improving, but bear in mind it is coming from a worse level. Inflation is almost tamed, the year-on-year rate down to 2.2% in August. Germany, the so-called motor of Europe, is struggling to keep its GDP in growth territory, but managed to stay out of a recession.
China is once again the “lame duck” with a poorly performing stock market and massive outflows from foreign investors. In a recent self-evaluation, it turned out that our negative view on China was our best call in the past 2 years, though we must admit that this view stems from geopolitical uncertainty rather than stock market performance expectation.
Our summary recommendations
During the short-lived volatile period of early August, we issued a few of our usual low strike structured products, but the swiftness of the recovery quickly brought coupons back to lower levels, showing once again that acting fast in times of volatility is key to getting attractive coupons that can be secured for 6, 9, or even 12 months.
In our most recent Investment Committee, we decided to increase our tactical allocation to alternatives, with the objective of increasing exposure to private credit and private infrastructure.
Chart of the month
Most of us have probably heard of the Sahm rule only recently, if ever. The rule states that when the three-month moving average of the unemployment rate is 0.5% higher than the lowest three-month moving average of the preceding 12 months, a recession has begun. We are now at 0.53%, and if the rule is to apply once again, we are about to enter a recession. We believe the rule is to be taken with a grain of salt, as it was designed based on back-testing, with only the Covid recession forecasted since the rule was theorized.
Data source: Bloomberg
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