Choose the culprit behind the sudden sell-off in stock markets but a common theme in all top contenders is complacency.
In the first case, it is the US Federal Reserve that stands accused, in the eyes of the market, of being asleep to the risk of a recession in the US. Friday’s weak jobs numbers intensified the worry that policymakers have waited too long to cut interest rates. Even if a US recession in the next year remains unlikely in the eyes of most economists (a 25% possibility, says Goldman Sachs, upping its forecast from 15%), it’s the difference from previous expectations that moves markets. At the start of 2024, virtually nobody was talking about a US recession; now it is a plausible outcome to be priced into models.
The second example of complacency is the super, soaraway performance of the US technology sector. From early 2023 until mid-2024, the likes of Nvidia went upwards in a straight line, more or less. Sceptics who said that it all felt a little bubbly, and pointed to parallels with the late 1990s bubble in dotcom stocks, were ignored in the stampede. But we’re now at a point where boring questions are being asked about when the vast sums of capital being invested in the AI revolution will earn a meaningful return. Given how far valuations have risen (even after the post-June mini-correction), it is impossible to say what a rethink might mean for short-term tech valuations. Momentum can work in both directions.
Then there is the special contribution to complacency from Japan, where the Nikkei 225 index fell a spectacular 12% on Monday. A modest rise in interest rates in Japan last week (from an extremely low level) has upset a favourite market game of borrowing in yen to buy high-yielding assets elsewhere. The yen has risen by 10% against the dollar in less than a month, which is a huge shift. The scale of Japan-related moves on Monday carried the whiff of leveraged bets getting scorched on a grand scale.
From that unlovely mix of market-moving factors, the US outlook is by far the most important. The Japanese carry trade has burned speculators many times in the past without causing wider damage. As for the AI revolution, investors in Nvidia are still sitting on a 100% capital gain this year, so should not be blind to the risk that it may be a case of too much, too soon. But nothing destroys stock market returns in all corners of the market quite like a recession.
The good news, of a sort, is that a one in four chance of a US downturn, if the forecast is roughly correct, still represents decent odds of a gentle-ish landing. But the less clear part – and the element that will guarantee a twitchy summer as every piece of economic data is suddenly given extra importance – is waiting for the US Fed to act to cut rates, as bond markets are now in effect demanding.
An emergency cut in interest rates feels highly unlikely, as things currently stand. Last week’s job report was bad, but Monday’s US services sector report pointed in the opposite direction by showing a strengthening in business activity and new orders. Thus plan A for the Fed will surely be to wait until its next scheduled meeting in mid-September. Anything else would be an admission of a mistake.
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But September suddenly feels a long way off. The S&P 500 index, despite it all, is still up about 10% this year, which leaves plenty of room for further wild days if investors decide the Fed has made a terrible error and the recession odds are worsening. August could be a long month.
