Understanding Market Volatility: Key Drivers and Insights
Global markets experienced a sharp selloff in August that has accelerated since US and Australian markets reached all-time highs in July. At the time of writing, the ASX200 is off 6% from its all-time high and 5.3% month to date. The S&P500 is down 8.5% from its all-time high and 6% month to date.
As we navigate through a period of increased market volatility, it is important to contextualise recent events and maintain a balanced perspective. While short-term fluctuations can be unsettling, they are a normal part of market behaviour where equity market pull backs of 5% or more typically occur frequently over the course of a year. These fluctuations are part of healthy market functioning.
The rise in market volatility can be attributed to several factors that have increased uncertainty and culminated in an increase in ‘risk off’ sentiment.
The sharp drop in the Nikkei Index of 12.4% was the worst day for Japanese equities since the “Black Monday” of 1987. This aggressive move was the result of the Bank of Japan (BOJ) increasing interest rates. As a result, the Yen has strengthened sharply and brought with it a reversal in the carry trade whereby investors borrow cheaply in Yen and invest offshore. This saw billions of dollars’ worth of assets liquidated across global investments to fund losses incurred from carry trade investments. The Nikkei has now experienced a significant rebound from this low point.
The weakening trend in US labour market data was highlighted by weak non-farm payrolls and a jump in the unemployment rate to 4.3%. Other economic data points have also emphasised a softening trend for the US economy with pressure on the crucial US consumer starting to show. Markets have become concerned that the Fed has held rates too high for too long in what would be a policy error, pushing the US economy into a recession. There has even been talk about emergency rate cuts from some commentators. The Fed is expected to cut rates by 0.25% in their September meeting.
The US Q2 earnings season has also weighed on investor sentiment. Expectations for Q2 earnings have been particularly elevated given the hyped earnings and growth expectations from technology companies, especially those linked to Artificial Intelligence (AI). With about 75% of companies having released earnings so far, results have been good with 79% of companies beating earnings expectations. However, forward guidance from some of the large cap technology companies have moderated some of the lofty growth expectations that investors had pencilled in. Despite reasonably strong results, large-cap technology companies have perhaps run ahead of their intrinsic value and have been trading at the top end of their historical valuation ranges. As future earnings expectations have moderated, there is a normal process of profit taking and the recycling of capital into cheaper areas of the markets.
Importantly, there are no signs of systemic issues such as a liquidity crisis or banking sector instability. The current volatility appears to be primarily sentiment-driven, reflecting the market’s uncertainty around future growth.
Markets can be unpredictable in the short term. However, maintaining a long-term perspective and a well-diversified portfolio remains the best strategy for navigating market turbulence. We are continually monitoring economic data and market movements. Our team is dedicated to analysing these developments and their potential impact on portfolios.
We remain confident that portfolios continue to be well diversified and positioned to enable them to achieve the required risk and return objectives over their investment horizon.
We encourage all our clients to stay informed and maintain a long-term perspective during these turbulent times. Our team at Middleton Financial Planning is here to support you with tailored advice and strategies. For more insights and to discuss your portfolio, please contact us or schedule a consultation with your adviser. Stay connected with us for the latest updates and market analyses.
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