We know from history that price swings happen, and we plan for this.

With stock markets seesawing the past couple of weeks, some investors may wonder what caused the recent downturn and what the future holds. Let’s get into this.

Stock Market Volatility

The S&P 500, often used as a proxy for the US stock market, has decreased 6.6% from July’s all-time high. The Dow Jones (-4.5%) and tech-heavy Nasdaq (-11.5%) indexes were down as well.

Headlines and Media Themes

“Lousy Jobs Report Forces Fed to Reckon With Hard Landing” (Wall Street Journal. 8/2/24)

“The popular ‘carry trade’ is unwinding — and economists fear Fed rate cuts could make matters worse” (CNBC. 8/6/24)

“Bank of Japan Walks Back Talk of Rate Increases After Roiling Markets” (Wall Street Journal. 8/7/24)

Vector's Thoughts

It’s rarely just one thing. Markets always respond to many supply and demand pressures, changes to political tickets or policies, and economic indicators like jobs and inflation rates.

Last Friday, August 2nd, 2024, the Bureau of Labor Statistics' jobs data came in weaker than expected. Their report signaled a slowing economy, and the stock market reacted by selling off.

The Central Bank (Fed) has a dual mandate: price stability and maximum employment. The weaker jobs report, combined with the slowing pace of inflation, leads us to believe that cuts to short-term interest rates are around the corner––possibly as soon as this September. Cutting short-term interest rates has historically boosted the economy and financial markets.

Economies are interconnected. Just as the US has the Fed, which sets interest rates, Japan also has a central bank. Recently, Japan’s “Fed” raised short-term interest rates. Japan is the third largest economy in the world behind the US and China and its policies have international ripples.

About the ‘Carry Trade’

The Japanese yen carry trade is a speculative financial strategy where investors borrow money in Japanese yen (JPY) at low interest rates and then invest that money in assets or securities in other countries. The idea is to profit from the difference between the low borrowing cost in Japan and the higher expected returns from investments elsewhere. Borrow low, sell high.

When Japan's central bank raised its interest rates, some investors unwound their leveraged carry trades, selling off US stocks, among other assets, contributing to greater market fluctuations.

Market Dips and Corrections

When investors see the value of their assets declining, words like dip and corrections can feel like euphemisms. That said, when we look back, we know that market prices go through periods of ups and downs, especially in the short term. On average, a 5% decline in the stock market occurs 3.4 times per year. A larger 10% decline, known as a moderate correction, occurs on average 1.1 times per year.

Vector’s investment philosophy prioritizes allocating assets for near-term expenses to more stable investments and allowing the longer-term segments of a portfolio to focus on growth. We know from history that price swings happen, and we plan for this, among other scenarios in your financial plan.

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