Markets plummeted. Here’s what you need to know.

Market Recap

• 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.