....there's one big elephant in the room that the market has even yet to contemplate that could cause the market train wreck to intensify as we progress to the final quarter of the year.
....the BIG political uncertainty stemming from the US elections ! Jim Rickards reckons we could face a -50% market wipeout in the coming months due to this - he may be just trying to sell his newsletter. But what I am prepared to recognise is that the market has yet to impute any negative outcomes which could range from a disorderly contested result, a Congress in disarray or more insidious political upheaval. If you want to hang around to see what that does to the markets, then you have decided it would be seamless, by default. The closer the polls get, the more uncertainty we face. It won't be easy, whichever party wins. Why recession panic is gripping the markets
Global markets are being lashed by a perfect storm of recession fears, volatility and AI scepticism. But there’s a key reason it threatens to turn into panic.
Aug 3, 2024 – 9.34am
They don’t ring a bell at the top of the market, or so the old saying goes. But often, they do utter a simple four-word phrase.
This time it’s different.
Goldman Sachs’ top strategist, David Kostin, released a note with that exact title in March, when he became the latest analyst to try and explain away the extreme valuations in tech stocks by arguing they didn’t look quite as extreme as in the past.
But let’s not pick on Kostin, who acknowledged at the time he was tempting fate. There have been plenty of variations on the “this time it’s different theme” in recent months – plenty suggesting the long inverted bond yield curve had lost its power to predict a recession; plenty arguing extreme sharemarket concentration was no big worry; plenty arguing that the mini bubble in artificial intelligence was nothing like what we saw in the DotCom era.
But suddenly, all those beliefs are being challenged by a perfect storm of market fears.
Scepticism about the AI boom has been building for weeks, and reached a crescendo following a set of June quarter profit results from big tech firms that can best be described as middling. While there was nothing really wrong with the earnings numbers, the size of the capital investment at companies like Microsoft and Amazon – running at $US140 billion ($215 billion) a year for just those two companies – has raised justified doubts about future returns on that spend.
That tech sell off has been compounded by the long-expected decision by the Bank of Japan to finally raise interest rates, which has forced the Yen higher against the US dollar, and helped unwind one of the world’s most popular carry trades – this is where investors borrow in a low-interest rate currency like the yen and invest the proceeds in higher yielding assets around the world.
A BOJ hike was always going to create volatility, but it’s arrived at precisely the wrong time – that is, just as a recession panic rocks Wall Street.
The rally we saw on Wall Street on Wednesday night after Federal Reserve chairman Jerome Powell strongly hinted at a September rate cut now seems a distant memory after two days of selling that saw the S&P fall 1.4 per cent on Thursday night and a further 1.8 per cent on Friday night.
The Nasdaq has now entered a correction, having fallen 10.1 per cent since its all-time high last month. The US 10-year bond yield fell to 3.8 per cent, below 4 per cent for the first time since last December. The VIX volatility index hit its highest point since March 2023, when the US banking crisis was in full swing.
A series of ugly data points have inflamed investors’ recession fears. On Thursday night, the market was spooked by weaker than expected data on job openings and a manufacturing activity gauge that showed US factories are going backwards.
But on Friday night came the real scare, when non-farm payroll data showed the US economy added 114,000 jobs in July, compared to expectations for 170,000 jobs, while the unemployment rate rose from 4.1 per cent to 4.3 per cent.
Notably, June’s labour market data was also revised down; downward revisions have now occurred six out of the last seven months.
The stunning change in sentiment was summed up perfectly by the bond market, which is now ascribing an 80 per cent chance that the Fed cuts rates by 0.5 per cent in September. A week ago it was just 12 per cent.
Incredibly, there was even talk that the central bank might have to hold an emergency meeting and cut rates outside of its usual cycle.
That’s not going to happen. For starters, the data doesn’t warrant it – the labour market might be softening, and fast, but for now we are mainly seeing a slowdown in hiring rather than a pick-up in firing.
And secondly, an intra-meeting cut would be a signal that the Fed is panicking, which really wouldn’t help anyone.
Powell and his colleagues will want to see more data before they decide how hard they need to go. July’s US retail sales numbers, and then the August jobs numbers, will now take on an out-sized importance.
Further, the US economy is arguably doing exactly what the Fed has been trying to engineer for two years, and finally cooling, bringing down inflation in the process.
So why the whiff of panic on Friday night? There are two reasons.
First, investors are remembering that every hard landing starts out as a soft landing. The path towards bringing down inflation without hurting the jobs market was always very narrow, and the potential for the Fed (or the Reserve Bank, for that matter) to leave rates too high for too long was always there. Now, those fears are suddenly front of mind.
Second, as Chanticleer has been banging on about for months now, investor positioning became too extreme.
They were so convinced about the AI story, the soft landing and earnings growth that we ended up with a market where valuations got too expensive (particularly compared to the returns on offer from bonds) and volatility was too low. They’d forgotten that markets typically fall when rates go down; since the 1970s, the S&P 500 has typically fallen by 23 per cent on average in the first 200 days or so following the first rate cut.
What we are seeing then isn’t just fears about a recession – it’s fears about recession, exacerbated by the fact that no one is remotely positioned for it. Or in other words, some investors are rushing from one side of the boat to the other.
There is, of course, a chance that this is another market head-fake: over-stretched positions get sold off a bit, the AI hype cools for a while and then another data point – say, Nvidia’s next earnings report, due at the end of August – gets the ball rolling again.
That’s exactly what happened earlier this year, and it could happen again.
But the difference now is that the economic backdrop has changed. Nick Ferres, chief investment officer at macro hedge fund Vantage Point, says it appears corporate profit margins are coming under pressure, and companies are no longer hoarding workers, leading to those deteriorating labour market numbers. In addition, Yen’s rise is creating problems in over-leveraged pockets of the market.
“We hear that some participants are asking ‘when do we buy this?’” he says. “In contrast we fear that we are not defensive enough.”
The ASX 200 fell 2.1 per cent on Friday, its worst day in more than a year, and futures point to a fall of 1.5 per cent on Monday. What’s particularly tricky for local investors is that we are heading into August reporting season, when volatility is always more pronounced.
Local investors are heading into a perfect storm – volatility from local earnings, a recession panic from the US, persistent and growing fears about China’s economy, and the Yen carry trade unwinding.
