The Math & Emotion of Market Volatility 

 Five Things You Should Know 

1. Equity Markets – moved slightly higher this week with U.S. stocks (S&P 500) up 0.06% and international stocks (EAFE) rising 0.40% 

2. Fixed Income Markets – finished mixed with investment-grade bonds (AGG) down –0.79% and high yield bonds (JNK) moving higher 0.21% 

3. Fed Pushes Back – While a string of weak data points has led to market choppiness some Fed officials were quick to push back on the likelihood for an imminent rate cut. Tom Barkin noted that the Fed has time to assess economic conditions before making any decisions on rate activity, while Jeffrey Schmid outright said he will not support a cut while inflation remains above target. 

4. BOJ Uncertainty – Following a surprising rate hike last week that sent global markets reeling investors are trying to navigate a new landscape and remain unsure on if the BOJ will stand by their comments that no further hikes will occur during market turmoil. JPMorgan believes that the unwinding of the yen-funded carry trade still has room to run. 

5. Key Insight – [VIDEO] It can be difficult to watch your portfolio value go up and down through periods of volatility. This week, we’ll talk about a few things to help you control your emotions and trust the process. [ARTICLE] Tim reviews the market turbulence of the last week providing some of his own perspectives, along with some from analysts he greatly respects. He also refers back to some prior commentaries and advice that could prove to helpful for navigating how to diversify and prepare for future market volatility. 

 INSIGHTS for INVESTORS 

Perhaps ironically, the first TEN Capital Weekly Commentary came in response to the equity sell-off in August (it was 2015 and at that time concerns around growth in China and possible effect on the broader global economy lead to a bear market in US stocks), and we’ve put one out every week since for 9 years. 

Equity weakness in August is nothing new, just since 2010 the S&P 500 index has declined in August six times, giving it the worst track record of any month. 

Furthermore, August as a seasonally weak month goes back much further than 2010. As reported by Barron’s, “According to data from Sam Stovall, chief investment strategist at CFRA Research, August is just one of three months where the S&P 500 has posted an average decline since 1945.” 

That said, the volatility and fear we experienced to begin the week is perhaps a bit overdone. As you can see from the screenshot below, early Monday morning the VIX index (a measure of volatility) spiked to levels that exceeded any of the daily “market close” levels seen during the dot.com crash, 2008 crisis or even COVID sell-off. (see chart below) 

Despite many repeated warnings to bank some gains and/or diversify in the commentaries this year (e.g. see May 24th, 2024 on adding to alternatives and June 7th, 2024 on the not falling prey to market narratives, i.e. AI and Fed superpowers suspending economy gravity), we feel the current market reaction is excessive. We’ve been in the camp for some time that some form a recession, or at least a big enough fear of one, was likely needed to slow down the US consumer and corresponding inflation levels but these types of VIX l 

levels are usually found during periods of systemic risk which one would be pressed to justify as defining the current environment. 

CBOE Volatility Index 

Source: Yahoo Finance, Date – 8/5/24 at 8:27am est 

Risk on… 

There is an old market adage that says, “risk happens slowly, and then all that once.” After reaching all-time highs in mid-July stoked by AI and “Fed put” narratives that suggested both would help suspend economic gravity and push markets higher. Volatility crashed the party and sent equities down sharply with the headline-grabbing NASDAQ Composite index dropping from its peak by more than 10%, marking an official correction for the index. 

The reason is a sudden shift in the narratives with AI’s true effectiveness now being called into question, and the Fed going from market savior to “behind the curve” seemingly overnight. 

This shift in mindset, coupled with weakening macro data … most notably in the once invincible labor market (July’s data showed job growth of just 114,000 vs. expectations for 175,000 along with downward revisions to prior months and jobless claims rising to 249,000) has renewed fears of a possible recession. See also the recent ISM Manufacturing Index which declined to 46.8, indicating economic contraction. 

Neil Dutta of Renaissance Macro highlighted the possible worrisome leading indicator for labor noting, “The single-most important data point within the Conference Board Survey is the Labor Differential, the gap between those saying jobs are plentiful versus those who are saying jobs are hard to get. It weakened to a fresh low of 18.1. Consumers tend to spot changes in their local economies ahead of the economic data and the deteriorating in attitudes around the job market suggests that additional increase in the unemployment rate are likely.” He concludes, “The Fed’s go-slow approach to recalibrating monetary policy is looking increasingly offsides relative to the incoming data. They ought to make a strong signal cuts are on the way to stabilize labor market conditions. The risk of higher unemployment is much higher than the risk of rising inflation.” 

The uptick in employment also triggered the so-called Sahm rule. As summarized by JPMorgan, “Much attention is now turning to the Sahm Rule, an economic indicator developed by Claudia Sahm that is designed to provide a real-time signal of the onset of a recession. 

Last week’s jobs report showed that the labor market is losing momentum at a faster than expected pace. While a 4.3% unemployment rate is still historically low, it has risen 0.6% since January, marking the fastest rise in a six-month period since the pandemic. The Sahm Rule has accurately signaled all 12 U.S. recessions since 1947. This week’s chart shows the four most recent recessions and how the Sahm Rule coincided with their onset. The July jobs report caused the three-month moving average of the unemployment rate to exceed its lowest level over the prior 12 months by 0.5%, triggering the Sahm Rule.” 

While the Sahm Rule is now causing concern, it should be noted that many other so-called recession indicators, like yield curve 

inversion, have been flashing red for a while without a recession occurring. While the economy continues to slow, broader data, including growth and PMIs, are far from recessionary levels. 

Against this backdrop, investors may want to evaluate their equity exposure, given strong performance in recent years, and focus on quality companies. Bond yields have already dropped around 65bps since the end of June, highlighting the value of bond duration in hedging equity risk. Investors may also want to correct underweights in core bonds, which can reduce portfolio volatility. Last week, while stocks were down 2%, core bonds were up 2%, reminding investors that bonds typically provide support during periods of growth concerns.” 

Source: JPMorgan, 8/5/24 

Adding to the “recession chorus” this last weekend was Goldman Sachs Group, who as reported by Bloomberg on X, raised their probabilities of US recession in the next year from 15% to 25%. 

This negative macro backdrop along with many of the recent technology stock darlings failing to post earnings in Q2 that could live up to investors’ lofty expectations, has markets sitting as precariously as they have since 2022’s bear market. 

A Bright Spot Among the Darkening Market Environment 

On the other hand, investment grade fixed income, real estate and other alternatives have got a major bid over this same timeframe (with the US Aggregate bond index up almost 4% just last week), seemingly renewing their place as risk-off equity diversifiers worthy of strong 

consideration by investors, as we’ve highlighted in prior commentaries (see 10/13/23, 5/24/24 and 7/26/24). 

The recent bond rally is due to both growing economic concerns, as well as consensus expecting the Fed to cut rates in September, these catalysts have served to push the entire yield curve down. The longer-end has had a solid move downward with the 10-year Treasury dropping to 3.79%, almost a full 1% decline from its year-to-date peak of 4.70%. That said, the 2-year Treasury yield has had seen an even bigger decline from a yield of over 5% in the spring to just 3.87% here in early August. Remember declining yields serve to boost current bond prices. There are still some attractive areas, but for those looking to make big moves after the fact, it’s another good reminder that one needs to buy “insurance” before the event not after. 

Fed Failure? 

After last week’s Fed meeting, and weak labor data, the consensus view is that the Fed is on to cut in September with some even calling for a 50 basis point cut. We remain skeptical that the Fed would take such action, and that view also fails to take into account the negative message that such a cut could send to markets about the state of the economy likely rendering moot any positives from such action. 

Furthermore, while the markets initially cheered the Powell’s indication of multiple rate cuts in 2024, last week’s subsequent sell-off suggests the market is waking up to the “why” behind such intentions. As commentator Tom Essaye cautioned “The Fed is clearly telling us they are going to cut in September. Powell also hinted at several rate cuts in 2024. Why? It’s not because inflation is so low they can cut aggressively. It’s because they are getting worried about growth and this just reinforces what is the key question for markets for the second half of 2024: We know that Fed is going to cut rates, but will they cut rates in time to avoid a slowdown?” 

Worrisome Trend or Short-term Slowdown? 

On the other side from those expressing concern/alarm stands Chicago Fed President Austan Goolsbee who urged patience regarding recent data and the direction of the Fed’s next move stating, “We’d never want to overreact to any one month’s numbers.” 

Torsten Slok, Chief Economist of Apollo, also urged investors to not give up just yet on the US economy stating that “There are no signs of a slowdown in restaurant bookings, TSA air travel data, tax withholdings, retail sales, hotel demand, bank lending, Broadway show attendance, and weekly box office grosses. Combined with GDP in the second quarter coming in at 2.8%, the bottom line is that the current state of the economy can be described as slowing, but still a soft landing.” 

This view is shared by the team at Trend Macro who responded to this week’s market volatility by saying “Sorry recession fans. You’ve got some ammo now, but the non-manufacturing ISM PMI at 51.4 doesn’t help your case. And the S&P Global version at 55 is even more evidence that the vast services sector, explaining 85% of jobs, is doing just fine.” 

Slok’s viewed is shared by Neil Dutta of Renaissance Macro Research who recently opined on the current environment, “If the Fed cuts aggressively then I think growth will stabilize. I think the Fed has committed a small policy mistake. But, I emphasize the word ‘small’. To the extent that made a mistake, it is one that can be undone relatively quickly. The issue right now is policy is too tight. There is no troubled asset relief program or resolution trust corporation that needs to be done to deal with things. The solution is simple: cut rates. If that does not work, then you can cut more. So, the mistake can be easily dealt with. The Fed just needs to step up to the plate.” 

While Gavekal research summed out their current outlook by saying, “factors suggest slower US growth. But do they point to a near-term recession? It’s possible, but very far from certain. The ISM manufacturing PMI fell further into contractionary territory in July. But the ISM services PMI climbed back above 50—suggesting the US is back to a two-speed economy. Many observers are worried because the three-month moving average of the unemployment rate has risen 50bp from its recent low, triggering the “Sahm rule” that historically has signaled recessions. But a clutch of trusted recession indicators have issued false signals in this cycle.” 

In Closing 

Markets rarely move in straight lines and with a number of technical indicators suggesting equities are approaching oversold conditions the commentary above should not be read as suggesting it’s time to hit the panic button. Panic, just like engaging in predictions, is not a process. 

However, if equities and other risk assets do experience a bounce it would be wise for all investors to use that as an opportunity to at least consider whether their portfolio reflects their true risk tolerance and is as diversified as it needs to be to meet both their emotional and financial needs, or whether they should lighten up their equity exposure. 

Such a period relief in the risk-off trade could also provide investors another chance to add asset classes that either trade at cheaper valuations and/or can serve as a diversifier to equities (see bonds, real estate, etc.). 

Have a wonderful weekend, 

Tim and the team at TEN Capital 

Data, Just the Data

U.S. Initial Jobless Claims – fell by 17K to 230K on the period ending August 3rd. This was below market expectations of 240K and followed an upwardly revised 250K in the previous week, which was the highest in a year. 

U.S. Mortgage Applications – soared by 6.9% from the previous week in the period ending August 2nd. This was the sharpest increase in nearly two months, and fully erased the cumulative declines in applications from the two prior weeks. 

U.S. ISM Serices PMI – rose to 51.4 in July of 2024. This was above market expectations of 51 to indicate a moderate rebound in US services activity. 

U.K. Construction PMI – jumped to 55.3 in July of 2024. This was above market expectations of 52.7 and slightly higher than June’s 52.2 reading. 

U.K. Services PMI – fell to 51.9 in July of 2024 from 52.8 in June. This aligned