Global markets have tumbled after US recession fears were ignited on the back of weaker-than-expected unemployment data.
Japan’s Nikkei index suffered its worst day since 1987 as it fell 12.4% today (5 August), wiping out the gains investors enjoyed earlier in the year, while other Asian markets also plunged, with South Korean equity markets falling the most in a single day since 2008.
While the impact was less pronounced in Europe, the FTSE 100 fell over 2% by 11am, while the STOXX 600 dropped 2.5%.
“The statistics we’re seeing right now are truly remarkable,” said Chris Metcalfe, IBOSS chief investment officer.
“Futures markets are also painting a grim picture, although it’s noteworthy that value stocks seem to be faring better than growth stocks. The sentiment hasn’t been helped by Warren Buffett’s decision to dump 50% of his Apple holdings, which has certainly contributed to the current market anxiety.
“Gold is holding up as something of a safe haven, but historically, in times of crisis, investors end up selling what they can rather than what they want to, which might eventually affect gold as well.”
See also: ‘Has the Fed made a mistake?’: Weak US jobs data sparks recession concerns
While Friday’s unemployment data was “disappointing but not catastrophic”, Metcalfe added there are several factors contributing to the current market upheaval.
“The Japanese central bank’s decision to raise rates seems particularly poorly timed, especially since the Federal Reserve might need to cut rates faster than anticipated. Earnings reports have been mixed, with tech companies delivering slightly disappointing results.
“Moreover, some stock valuations have reached unreasonable levels, and we’re now seeing an unwinding of leveraged trades, which is exacerbating the market movements.”
Morgane Delledonne, head of investment strategy at Global X ETFs added that, despite the latest earning reports from the Magnificent Seven looking relatively strong, investors are losing patience regarding the return on AI investments.
“Tech companies continue to invest massively in Generative AI but remain shy about quantifying the potential revenue or the timeline,” she said.
“Given their higher valuation relative to other sectors boosted by expectations on future growth, large tech companies are naturally more prone to volatility during risk-off events like today despite strong fundamentals and past performances.”
The Magnificent Seven stocks have lost a combined 15%, or $2.3trn, of their market cap since peaking in July, though they’re still collectively valued at $14.7trn.
Macro backdrop ‘not as terminal’ as markets suggest
Despite the reaction from markets, the macroeconomic backdrop is not as terminal as it may currently appear, according to abrdn economist Michael Langham.
“US recession fears are back as a dominant theme, driven by a combination of a rapid loss of momentum in the labour market and reports of soft consumer demand in earnings reports. Market pricing is now indicating a belief that the Fed is behind the curve and will cut rapidly in upcoming meetings to avoid a hard landing. This has all spilled into Asian markets, with carry trades unwinding and risk-off sentiment prevalent.
“However, we think the macro backdrop isn’t as terminal as markets are indicating. Strong labour supply growth in recent years has helped to cool the labour market and layoffs remain low in the US.
“In Asia, the upturn in tech exports and still buoyant domestic demand shouldn’t set alarm bells ringing yet for policymakers. We expect the Fed to begin easing in September, which should provide the runway for cutting cycles in parts of emerging Asia, and likely further stimulus in China could also have some positive spillovers, softening any slowdown in the region.”
Amid the equity market volatility, US Treasuries have rallied as investors look for a safe haven trade.
“Market participants have lost confidence in the Fed’s ability to avoid a recession after the slightly disappointing job report for July,” said Global X’s Delledonne.
“Fed funds futures are now fully priced at a 125bps reduction in interest rates by year end, which is five times above the FOMC median projection for the year. This massive dis-anchoring of market expectations from the Fed’s guidance is a real test for equity markets.
“The current US economic data is not suggesting a significant slowdown that would justify emergency cuts of 50bps from September as markets suggest. This risk-off sentiment is widening as investors seem increasingly concerned about future growth based on a softening of the US job market while the Fed’s posture stays still because there is currently no evidence of a risk of recession from the latest economic data.”
See also: Crisis point: Concerns grow over mounting government debt levels
She added that volatility is likely to remain high in the build up to the Fed’s September meeting and amid the presidential elections.
“The conflicting reading of the US economy from market and the Fed is likely to keep market volatility high, favouring buffer strategies for risk management while keeping invested.”
IBOSS’s Metcalfe added that the volatility could encourage a shift into bonds.
“There has been considerable debate among advisers and commentators about whether to move away from bonds in favour of equities and cash. Even before the recent selloff in the US and the dramatic collapses in Japan and other parts of Asia, data suggested that higher-yielding assets were undervalued compared to equities.
“If market volatility continues, we might see a shift back into bonds, as they are currently acting as a safe haven. This trend is likely to persist if equities remain unstable, providing a more secure option for investors during these turbulent times.”
