Weekly comment: Stocks end volatile week little changed

Market overview – Richard Carter, Head of Fixed Interest Research

Equity markets recovered from a sizable drop to end last week and little changed, with the MSCI All Country World Index effectively flat for the week and still up 9.7% YTD. Bond yields drifted a little higher, paring recent declines as stocks recovered.

The recovery was based on a growing feeling that the sell-off following the monthly US jobs report and key central bank decisions around the turn of the month was perhaps overdone. Technical factors, such as the unwinding of carry trades, appear to have exacerbated the declines. The unexpected move to raise Japanese interest rates sparked a sharp rally in the yen, as more and more flows rushed to exit carry trade positions.

The carry trade had seemingly been based on borrowing in Japan at near-zero interest rates to invest in higher-yielding assets, such as US tech stocks, emerging market currencies and cryptocurrencies. The Japanese currency appreciation swiftly ate into profits from these positions, leading to a hurry to exit.

On Monday August 5 morning, US stock benchmarks verged on correction territory, defined by a 10% drawdown, while tech-based indices were some 15%-16% off recent highs. This was accompanied by a sharp move higher in the volatility index which briefly hit its highest level since the Covid-19 pandemic.

It is the nature of markets to overreact, particularly when falling, and it remains a key tenet of successful investing to avoid panicking and selling into a capitulation bottom. This was demonstrated last week as markets gradually recovered as the week progressed to leave US indices broadly flat.

European markets fared better, with UK benchmarks rising 0.2% (8.3% YTD) and the MSCI Europe ex UK ending up 0.5% (5.5% YTD) on the week. The 10-year gilt yield rose 11 basis points on the week to end at 3.94% while the pound ended little changed against the US dollar at 1.28.

Data watch 

Following the negative reaction to the latest non-farm payrolls release, concerns were raised regarding the strength of the US economy. Analysis since the data dropped reveals that there are quite possibly several factors which contributed to this reading being worse than it otherwise would have been, causing market observers to take a keener interest in subsequent data points.

Shortly after the US markets opened on Monday a better than expected ISM services purchasing managers’ index reading assuaged some worry. This was further supported by a fall in the initial jobless claims’ figures, showing a significant weekly drop to 233k from 250k. Expectations for central bank cuts have been ramped up following the recent market weakness and upcoming data points will no doubt be carefully followed.

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