Storm in a teacup

Last week started with a bang but ended with a whimper. Japanese equities on Monday fell as much as 12%, their largest one-day decline since 1987, and global equities ended the day down 3.5%. But Tuesday then saw a sharp rebound in Tokyo and global markets spent the rest of the week recovering Monday’s losses.

Over the week as a whole, global equities ended little changed. To give a bit more perspective, markets at their low point last Monday were down 9% in local currency terms and 7% in sterling terms from their mid-July high. They have subsequently recovered a bit over 3% on both measures and are currently up a strong 8-9% since the start of the year.

The market decline – aside from the wild swings in Japan – was really nothing out of the ordinary. The largest peak-to-trough drawdown seen in any one year in US equities has on average been 10%, little different from the 9% drop this time.

Now the dust has settled, it is worth noting which markets have held up best. From the mid-July high, Japan is down most, falling 6% in sterling terms. The US also fared relatively badly as a result of tech stocks leading the decline and is down 4%. By contrast, UK equities have performed best and are broadly unchanged, benefiting from their relatively large weighting in the more defensive sectors which have held up well.

As for bonds, they posted losses of 0.5 – 1% last week, unwinding a bit of their gains the previous week. Bond yields rose as the market scaled back its new-found hopes of rapid rate cuts by the US Fed. Even so, the market still believes there is a 50-50 chance that rates will be cut in September by 0.5% rather than just 0.25% and expects rates to be 1.0% lower by year-end.

We stated in last week’s commentary that we did not believe the medium term outlook has changed significantly and remains reasonably positive. After further reflection at our latest investment policy meeting, we stick to this view. The key call is still whether or not the US is heading into a recession and we don’t think it is.

Last week was a quiet one on the data front but there were a couple of second tier US economic releases and they were reassuring. Indeed, the latest forecasts see US growth continuing to run at a robust 2.5-3% in the third quarter, similar to the pace in the previous three months.

While the economic outlook in the US has not changed that much, the political outlook has changed dramatically over the last month. All of a month ago, Donald Trump was riding high after the failed assassination attempt and Joe Biden was floundering. Now, Kamala Harris has reinvigorated the Democratic campaign, closed much of the poll gap in the key battleground states and is seen as the favourite on all the major betting sites.

We have all along been sceptical about the wisdom of changing one’s investment allocation on the basis of the US elections. And with the results once again looking a very close call, both as to who wins the Presidency and also importantly who gains control of Congress, this very much remains our position.

We believe equity markets, particularly the cheaper areas outside the US, have potential for renewed gains over the coming year. Still, coming weeks could well see market volatility remain on the high side. The recent sharp market moves will undoubtedly have triggered significant changes in positioning, particularly of quant-driven strategies, and quite possibly significant losses in some cases. It is still too early to know exactly how these play out.

We also have the July US inflation data out on Thursday which will be a major focus for investors this week. Here in the UK, it is a busy week with labour market numbers on Tuesday, July inflation data on Wednesday and second quarter growth figures on Thursday. These will all be important in determining whether, as the market currently expects, the Bank of England keeps rates unchanged in September and delays the next cut until November.

Rupert Thompson – Chief Economist