Market Commentary - August 2024

Monthly Update

Stock market activity took us on a wild ride in August and if you include the first trading day of September, all we did was run to stand still. The S&P 500 started the month at 5522, ended at 5648 and closed on the first trading day of September at 5529[1]. I believe there were a few major changes in tone that we must take note of. On August 1^st we saw an initial jobless claims figure, one that measures the weekly pace of those initially filing for unemployment benefits, that surprised to the upside and stocks sold off. This was followed the next day by a softer than expected monthly jobs report for July which resulted in further pressure on stocks. And then on the following Monday, the S&P sold off by 3% in reaction to a combination of economic worries and excessive bullishness that needed to be unwound, and which was very much exaggerated by the unwind of a seemingly massive yen carry trade. We can define this trade as borrowing cheaply in Japan with interest rates very low there and using the proceeds to speculate in both further yen weakening and buying other assets.

The trigger for the carry trade reversal was a 25-basis point rate increase by the Bank of Japan and commitment to further slowing the pace of asset purchases[2]. Japan has been dealing with higher inflation and a weak currency that only until recently did they finally get around to doing something about it.

The yen rallied 2.6% in August after jumping by 7.3% in July off the weakest level versus the US dollar since 1986[3]. A weak yen has damaged the purchasing power of the Japanese citizenry, especially one that imports almost all its energy needs. This, combined with above 2% inflation consistently, has put a lot of governmental and societal pressure on the Bank of Japan to confront it with tighter policy. On that August 1^st trading day discussed above, the Nikkei fell 2.5%[4]. On August 2^nd it sold off again by 5.8% and on Monday August 5^th, it crashed by another 12.4%[5]. As nerves calmed and the yen carry trade mostly unwound, we think, the Nikkei has recaptured most of what it lost.

I’m spending time here talking about Japan because Japan for decades has been the epicenter for extraordinary and experimental monetary policy and what happens there in its reversal has ripple effects throughout world markets.

Also of importance, in terms of the shifting tone in the market has been the splintering of the AI trade. We must recognize that the excitement surrounding Generative AI, which began to significantly influence the stock market in early 2023, provided the S&P 500 and the tech-heavy NASDAQ with a much-needed boost after their tough performance in 2022. The hype added literally trillions in market capitalization to the largest names we all know like Meta, Google/Alphabet, Amazon, Microsoft, Apple and the biggest beneficiary right now, Nvidia, the seller of the chips that power the needed computing power for these large language models.

What second quarter earnings brought us though was the market differentiating between the spenders on AI and the receivers of that spend. The spenders are spending unbelievable amounts of money building out their models with cap expenditures amounting to around $15b per quarter from the names listed above, according to their earnings call comments. Nvidia is the receiver of a lot of that but even for them, their sales growth is slowing down but to still an impressive rate. These are all incredible companies doing amazing things, but their stock prices got to the point of reflecting so much good news with market caps in some cases equaling or exceeding the GDP size of some countries.

To add more color to the change in market tone is that now softer economic news is now driving softer stock prices and vice versa. I mentioned earlier that stocks sold off on weaker economic data but then bounced when some data point came in better than expected. What this means is that the Federal Reserve is less relevant in terms of driving markets and a lot of that has to do with the bond market already pricing in 100 basis points of rate cuts by year end and an additional 100 basis points of cuts by next August.

I mentioned the recent strength of the yen over the past few months off near 40 yr lows, but the US dollar has been broadly weaker against many currencies. In particular, the Singapore dollar is trading near 10-year highs vs the US dollar[6]. The euro and pound are near two-year highs. A main driver of foreign exchange cross rates has typically been interest rate differentials between two countries. And that is an influence here for sure as the Fed is about to cut interest rates. But outside of the Bank of Japan, which is looking to hike again, other central banks are cutting rates too. On the day of this writing, the Bank of Canada cut interest rates for a 3^rd time this year in 25 basis point increments, to use as an example and the European Central Bank will soon follow with its second one[7]. This has me wondering whether the broad US dollar weakness is partly in response to growing international worry with ever rising US debts and deficits which continue to alarm in its size.

A big beneficiary of the US dollar weakness has been the price of gold. Gold finished August at about a record high and up by 17% for the front month futures contract year to date[8]. Silver too is up by a similar amount but has been more flattish of late as it sometimes trades like an industrial metal rather than a monetary one and worries about economic growth kept a lid on it. We remain optimistic about the prices for both and view gold as a currency that is competing with other fiat currencies. Central banks have been voracious buyers of gold over the past 2 ½ years in the face of higher real rates and a strong dollar and that is because of their desire to diversify their reserves away from the dollar.

Quickly here on the US economy, and the global one for that matter, it remains very mixed. Strength is being mostly driven by higher income spend, mostly on travel, leisure and hospitality, in addition to cap ex spend on anything AI, along with huge amounts of government spending that continues to flow through the economy, particularly in healthcare, defense, interest expense (and benefiting those receiving that interest income) and related to infrastructure and CHIPS Act and Inflation Reduction Act beneficiaries. Lower to middle income households are struggling with respect to consumer spending. Manufacturing is in a recession. Housing is mixed with the pace of existing home sales near 30-year lows, but new builds are doing better. Overseas, China’s growth is slowing but India’s GDP rate is robust. Germany is seeing no growth, but the UK and Spain are growing more notably. Mixed indeed.

Conclusion

It was another wild ride in markets in August and we should take note of the changing tone of the markets as stated. We’ve had an amazing run in stocks off the October 2022 lows and we just want to have eyes wide open if it is time to take a rest and the investing landscape is changing.

As I’ve stated over the past few months in these letters, investing and market/economic forecasting is a humbling business and why we are always diligent when it comes to investing client money in terms of constantly gauging the risk and reward and taking a long-term time horizon perspective. That allows us to ignore much of the short-term noise and focus most on the bigger picture. I say this all because it now seems like we’re in an even more uncertain time with so many cross currents to juggle.

We acknowledge that we live in a different macro world than enjoyed in the 15 years pre-Covid and the resumption of easy money that took place to help economically get us out of the self-imposed shutdowns. While the Fed is going to soon cut interest rates and maybe the market is right that it will total 200 basis points by next summer, a 3.5% fed funds rate from 5.5% currently is still a far cry from zero.

Whatever comes our way though in this very tricky investing landscape, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the market. Time horizon is always crucial and is always the best friend of any investor. We are not just in the asset management business but also in the risk management business and always believe that by watching our back and focusing on the risks, the upside should take care of itself.

Disclaimer

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[1] Bloomberg

[2] Reuters

[3] Bloomberg

[4] Bloomberg

[5] Bloomberg

[6] Bloomberg

[7] Reuters

[8] Bloomberg