Equity markets fell this week as softer U.S. economic data heightened growth concerns, and blew the door open for more aggressive near-term Federal Reserve easing, even as they left policy unchanged.
The S&P 500 fell 2.1%, with banks shedding 8% while technology and most cyclicals were also under serious pressure. The TSX gave back 2.6% with similar areas of weakness, but rate-sensitives actually caught some relief and posted solid gains on the week.
Indeed, 10-year Treasury yields crumbled to 3.8%, now down almost 100 bps from the April high, while the closely-watched 5-year GoC yield fell to the lowest level since early-2023.
What Happened
The events of the past several days are likely already known to many readers, but to briefly recap the key points: On Friday, a disappointing U.S. jobs report sent shockwaves through markets. After a weekend of digesting this data (including weak ISM manufacturing numbers), stocks fell sharply on Monday, with the Magnificent 7 getting particularly hard-hit as higher-valuation names lost momentum. Even Tech stocks that had reported positive earnings—including Meta, Apple, and Alphabet (Google)—sold off. Financials were hit as well, as a weak consumer is generally not good for that sector. In all, it was the worst day for the Dow and S&P 500 since 2022.
In taking stock of these events, the first and arguably most important thing to understand is that the reaction was based on a single piece of the puzzle, in the form of the bad jobs report. Markets often assume that they can see the full picture based on one piece, but that’s usually not the case. Instead, you need to look at the bigger picture—all the pieces from throughout the year that together give a better view of the economy. Through that lens, it becomes easier to understand what happened. We’ve been seeing a gradual softening of the consumer for at least three months; I’ve discussed it often in this space. The shift in consumer spending from Discretionary to Staples is real, and savings have been largely depleted. If markets had adjusted to that information gradually over the course of 90 days, we wouldn’t be talking about it now. Instead, markets overreacted to the relative economic resilience on the positive side for as long as they could, then overreacted on the negative side when a bad data point came along. Simultaneous with this overreaction was the unwinding of the yen carry trade, in which an investor borrows a currency when interest rates are low and uses it to invest in a currency with higher rates. Low rates in Japan meant that the yen was the most popular carry trade currency recently, but the decision by the Bank of Japan last week to hike rates effectively ended the trade and led to a historic plunge of Japanese stocks. That served as an exclamation point on top of what was happening in Western markets.
In totality, we believe that markets and the economy are not as bad today as many investors think, and not as good as they thought two or three months ago. We expect some selling to continue, though the most extreme part of the decline may be behind us. On Tuesday morning, markets did rebound as expected (though not fully reversing the declines of Monday), which tells us that there are buyers on the dip but also that some investors are still nervous. In our view, this is not a time to leave markets and sit on the sidelines but rather to look for opportunities.
Bottom Line: All year, markets were overestimating the strength of the economy. Now, they’re likely underestimating it.
What Investors Can Do
First things first: don’t overreact. There is no need to panic. One data point, no matter how bad, does not make a story, and some kind of pullback had been warranted for several months—what’s unfortunate is that it all happened over a few days. Secondly, keep your focus on the longer term. Leaving equity markets now would be a mistake, in our view, because timing the market is notoriously difficult; when you try to miss out on the worst of the downside, you run the risk of missing the best of the upside as well. Instead, buying on the dips often makes sense, and there may now be an opportunity to rotate into beaten-up names that had not participated in the rally. There’s also nothing wrong with taking profits when prudent and implementing some protection in your portfolio while staying invested, as we’ve done recently. This kind of scenario is why many investors turn to investment professionals—we watch multiple angles, avoid going all-in on any one trade or sector, and can make adjustments as necessary while not overreacting to near-term market conditions.
Bottom Line: This is not the time to panic. Rather, we prefer to ride out the storm and keep our eyes on the long term while buying on dips.
What it Means for Interest Rates
Last week, the U.S. Federal Reserve (Fed) opted to hold interest rates steady, which came as no surprise to markets. The real news at the time was the comments made by Fed chairman Jerome Powell. Powell indicated that September could be an opportune time for a rate cut but didn’t fully commit because of the Fed’s data dependence, which gives him an out in case inflation suddenly and unexpectedly spikes. The key moment was when he was asked whether the continuation of current trends would mean a rate cut in September, and his answer was a qualified ‘yes.’ Crucially, Powell also downplayed the possibility of a 50-bps cut. While much has changed since then, we viewed that as good news, because that kind of rate move could spook markets on the assumption that it must mean the Fed was starting too late. Right after the Fed’s meeting, bond markets were pricing in a nearly 100% chance of a rate cut in September, as well as two additional cuts before the end of the year. After the recent jobs number, this has changed dramatically, as there is now an over 70% probability of a 50 bps in September and five total rate cuts by January 2025 being predicted. What a difference a data point makes. Keep in mind, though, that the Fed said they are data dependant, not date dependent. This is one data point, and there will be more before September. Furthermore, the Sahm Rule has now been triggered. The Sahm rule indicates that an economy is in recession when the three-month moving average of the unemployment rate exceeds the lowest three-month moving average unemployment rate from the previous 12 months by 0.5% or more. We think an emergency rate cute, which some commentators and politicians have called for, is unlikely as it would essentially be an admission of error on the Fed’s part—plus, the September meeting is only about six weeks away. We currently think a 25-bps cut for September is the most likely scenario but also think at least two more cuts could occur by the end of the year.
Bottom Line: Markets moved higher on Powell’s comments, which seemed to indicate that a September rate cut is more likely than ever. However, all the momentum was lost when fears of an eroding economy popped up the next day.
Disclosures:
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.
For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.
®/™Registered trademarks/trademark of Bank of Montreal, used under licence.
What have we learned since last week’s big stock market tumble? How would an accelerated rate cut schedule impact the bond market? And what is the state of the U.S. presidential race now that Kamala Harris has selected a running mate?
Peak earnings? Why an equity rotation may be nearing.
What are the big takeaways from the latest round of earnings announcements? How will Kamala Harris’ ascension to the top of the Democratic ticket impact the presidential race and markets?
What does Biden pulling out of the U.S. presidential race mean for markets? With Tech stocks slumping, are concerns about a chip war between China and the U.S. warranted? And will the Bank of Canada cut rates again this week?
Politics and profits: Finding wins in an election year
The bad news is that the economic environment is worse than it was one year ago. The good news is that it is still in a pretty strong position and we’re not seeing any signs in the marketplace worrisome enough to warrant taking significant risk off the table.
Should investors consider rotating into equities with smaller market capitalizations? What did the latest CPI report tell us about the odds of a September rate cut? And where along the yield curve should investors look for opportunities?
This information is for Investment Advisors only. By accepting, you certify that you are an Investment Advisor. If you are NOT an Investment Advisor, please decline and view the content in the Investor or Institutional areas of the site. The website is for informational purposes only and is not intended to provide a complete description of BMO Global Asset Management’s products or services. Past performance is not indicative of future results. It should not be construed as investment advice or relied upon in making an investment decision. The opinions expressed are subject to change without notice. Products and services of BMO Global Asset Management are only offered in jurisdictions where they may be lawfully offered for sale. The information contained in this website does not constitute an offer or solicitation by anyone to buy or sell any investment fund or other product, service or information to anyone in any jurisdiction in which an offer or solicitation is not authorized or cannot be legally made or to any person to whom it is unlawful to make an offer of solicitation. All products and services are subject to the terms of each and every applicable agreement. It is important to note that not all products, services and information are available in all jurisdictions outside Canada.
Markets plummeted. Here’s what you need to know.
August 6 to 9, 2024
Markets plummeted. Here’s what you need to know.
August 6 to 9, 2024
Sadiq S. Adatia, CFA, FSA, FCIA
Market Recap
What Happened
The events of the past several days are likely already known to many readers, but to briefly recap the key points: On Friday, a disappointing U.S. jobs report sent shockwaves through markets. After a weekend of digesting this data (including weak ISM manufacturing numbers), stocks fell sharply on Monday, with the Magnificent 7 getting particularly hard-hit as higher-valuation names lost momentum. Even Tech stocks that had reported positive earnings—including Meta, Apple, and Alphabet (Google)—sold off. Financials were hit as well, as a weak consumer is generally not good for that sector. In all, it was the worst day for the Dow and S&P 500 since 2022.
In taking stock of these events, the first and arguably most important thing to understand is that the reaction was based on a single piece of the puzzle, in the form of the bad jobs report. Markets often assume that they can see the full picture based on one piece, but that’s usually not the case. Instead, you need to look at the bigger picture—all the pieces from throughout the year that together give a better view of the economy. Through that lens, it becomes easier to understand what happened. We’ve been seeing a gradual softening of the consumer for at least three months; I’ve discussed it often in this space. The shift in consumer spending from Discretionary to Staples is real, and savings have been largely depleted. If markets had adjusted to that information gradually over the course of 90 days, we wouldn’t be talking about it now. Instead, markets overreacted to the relative economic resilience on the positive side for as long as they could, then overreacted on the negative side when a bad data point came along. Simultaneous with this overreaction was the unwinding of the yen carry trade, in which an investor borrows a currency when interest rates are low and uses it to invest in a currency with higher rates. Low rates in Japan meant that the yen was the most popular carry trade currency recently, but the decision by the Bank of Japan last week to hike rates effectively ended the trade and led to a historic plunge of Japanese stocks. That served as an exclamation point on top of what was happening in Western markets.
In totality, we believe that markets and the economy are not as bad today as many investors think, and not as good as they thought two or three months ago. We expect some selling to continue, though the most extreme part of the decline may be behind us. On Tuesday morning, markets did rebound as expected (though not fully reversing the declines of Monday), which tells us that there are buyers on the dip but also that some investors are still nervous. In our view, this is not a time to leave markets and sit on the sidelines but rather to look for opportunities.
Bottom Line: All year, markets were overestimating the strength of the economy. Now, they’re likely underestimating it.
What Investors Can Do
First things first: don’t overreact. There is no need to panic. One data point, no matter how bad, does not make a story, and some kind of pullback had been warranted for several months—what’s unfortunate is that it all happened over a few days. Secondly, keep your focus on the longer term. Leaving equity markets now would be a mistake, in our view, because timing the market is notoriously difficult; when you try to miss out on the worst of the downside, you run the risk of missing the best of the upside as well. Instead, buying on the dips often makes sense, and there may now be an opportunity to rotate into beaten-up names that had not participated in the rally. There’s also nothing wrong with taking profits when prudent and implementing some protection in your portfolio while staying invested, as we’ve done recently. This kind of scenario is why many investors turn to investment professionals—we watch multiple angles, avoid going all-in on any one trade or sector, and can make adjustments as necessary while not overreacting to near-term market conditions.
Bottom Line: This is not the time to panic. Rather, we prefer to ride out the storm and keep our eyes on the long term while buying on dips.
What it Means for Interest Rates
Last week, the U.S. Federal Reserve (Fed) opted to hold interest rates steady, which came as no surprise to markets. The real news at the time was the comments made by Fed chairman Jerome Powell. Powell indicated that September could be an opportune time for a rate cut but didn’t fully commit because of the Fed’s data dependence, which gives him an out in case inflation suddenly and unexpectedly spikes. The key moment was when he was asked whether the continuation of current trends would mean a rate cut in September, and his answer was a qualified ‘yes.’ Crucially, Powell also downplayed the possibility of a 50-bps cut. While much has changed since then, we viewed that as good news, because that kind of rate move could spook markets on the assumption that it must mean the Fed was starting too late. Right after the Fed’s meeting, bond markets were pricing in a nearly 100% chance of a rate cut in September, as well as two additional cuts before the end of the year. After the recent jobs number, this has changed dramatically, as there is now an over 70% probability of a 50 bps in September and five total rate cuts by January 2025 being predicted. What a difference a data point makes. Keep in mind, though, that the Fed said they are data dependant, not date dependent. This is one data point, and there will be more before September. Furthermore, the Sahm Rule has now been triggered. The Sahm rule indicates that an economy is in recession when the three-month moving average of the unemployment rate exceeds the lowest three-month moving average unemployment rate from the previous 12 months by 0.5% or more. We think an emergency rate cute, which some commentators and politicians have called for, is unlikely as it would essentially be an admission of error on the Fed’s part—plus, the September meeting is only about six weeks away. We currently think a 25-bps cut for September is the most likely scenario but also think at least two more cuts could occur by the end of the year.
Bottom Line: Markets moved higher on Powell’s comments, which seemed to indicate that a September rate cut is more likely than ever. However, all the momentum was lost when fears of an eroding economy popped up the next day.
Disclosures:
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.
For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.
®/™Registered trademarks/trademark of Bank of Montreal, used under licence.
Insights
Riding the market’s roller coaster
BMO ETF Portfolios’ August commentary: “Special Report: Summer Sell-Off Rattles Risk Assets”
Peak earnings? Why an equity rotation may be nearing.
Biden pulls out. What next?
Politics and profits: Finding wins in an election year
Is it time to swap Big Tech for Small Caps?