Market Brief: Making Sense of This Week’s Market Volatility

It’s been a whirlwind of a week, and many of us are struggling to keep up with the rapidly changing market.

To provide clarity, we asked Emmy Sakulrompochai, head of Arta’s investment advisory practice, to distill this week’s events and analysis into actionable insights.

Leveraging insights from various institutions, Emmy offers a brief digest to help us make sense of the current financial landscape. Here’s her take on this week.

What has happened in the market?

• Market volatility has spiked, with VIX (CBOE Volatility Index) surging to its highest level in more than four years. This VIX level on August 5 was the highest level the VIX has hit since March 2020 during the COVID-19 pandemic.

• After the almost 20% rally since the beginning of this year, the S&P 500 has fallen -7.5% since its peak of 5,667 in mid-July to 5,240 as of August 6, 2024. 

• Nasdaq experienced even more volatility after rallying 23% since the beginning of this year and a 13% decline since the peak in mid-July to ~18,000 on August 6.

What’s behind the recent market volatility?

• Is the Fed behind the curve? 

  • Investors are increasingly concerned that the Federal Reserve may be behind the curve in cutting rates, given recent signs of a weakening labor market and declining manufacturing numbers. The Fed has held rates steady at 5.25-5.50% since July 2023, aiming to curb inflation. With the Fed’s preferred inflation gauge, core PCE, dropping significantly from 4.2% in July last year to 2.6% (as of August 1, 2024), Fed Chair Powell has hinted that a rate cut in September could be “on the table.”

  • This has led the futures markets to almost fully price in a 50 basis point rate cut in September and expect a total of 125 basis points in cuts by year-end. However, investors are concerned that the Fed’s delayed response could increase the likelihood of a recession given the latest softer economic data.

• Softer economic data

  • Recent economic indicators point to a cooling labor market, with the unemployment rate rising from 3.5% in July 2023 to 4.1%, and wage growth slowing, as July’s average hourly earnings marked the slowest annual increase since 2021. This softer-than-expected employment report, which reflected both lower payroll job gains and a higher unemployment rate, raises concerns that the labor market is cooling more rapidly than anticipated. Additionally, weak readings in construction, durable goods orders, home sales, and manufacturing activity further underscore the concern on economic growth.

• Magnificent 7 CAPEX spending on AI

  • While the major Magnificent 7 companies reported strong 2Q24 earnings, beating both EPS and revenue expectations, they have so far experienced an average 1-day return of -0.4%. This negative response is largely due to concerns over increased CAPEX spending as these companies compete in the AI race. Although AI is expected to drive efficiency and long-term growth, investors are cautious about the near-term impact of higher CAPEX and the uncertainty surrounding tangible revenue benefits. Additionally, with Magnificent 7 stocks running up ~29% YTD as of July 31, the already stretched valuations, which are driven mainly by multiple expansion, have further contributed to their vulnerability to negative news, leading to lower valuations than at the start of the year.

What’s keeping us calm

• Growth is there

  • 2Q24 GDP growth came in at 2.5% quarter-over-quarter, surpassing the 1.9% expectation and last quarter’s 1.4%. While the U.S. economy has cooled from its 4.1% pace in the second half of 2023, growth averaged a solid 2.1% in the first half of 2024, driven by a concentrated CAPEX boom in data centers, green industry, renewable energy, and infrastructure—sectors experiencing growth unlike any observed in over 20 years.

• Earnings is growing despite slowing economic growth

  • 75% of the companies who have reported so far beat EPS estimates, compared to an average of 74% over the last four quarters. This beat rate is especially impressive given analysts lowered their estimates by less than usual heading into the earnings season. However, things are less positive on the revenue side with only 56% of companies beating on revenues compared to an average of 60% over the last four quarters. 

What should you do?

• Focus on your long-term plan, not market timing

  • Market timing—trying to buy at the bottom and sell at the peak—is notoriously difficult and rarely successful. Emotions like fear and greed often lead to poor decisions, whether it’s chasing rising markets due to FOMO or panic-selling during a downturn. Stick with your long-term plan instead and if you don’t have one, this is a signal that you need to create one.

• Build a long-term, diversified portfolio

  • A well-diversified, long-term investment plan provides steady growth and resilience, with each asset class complementing the others across various market conditions. For example, during recent equity market sell-offs, bond prices have actually risen.

  • As equity investors panicked over slower growth, the potential rate cut in September drove down the 10-year Treasury yield, leading to higher bond prices. This illustrates how bonds can provide crucial diversification in your portfolio.

  • While diversifying within public markets is valuable, investors with access to private markets should leverage this opportunity to build an even more diversified portfolio across both public and private assets. The low correlation between alternative asset classes enhances risk-adjusted returns and strengthens portfolio resilience over the long term. For example, while public equities rallied in 2023 and early 2024, the private equity market struggled with the higher interest rate environment. However, as public equities now face turbulence, the private equity market is on a recovery path, supported by potential rate cuts. Diversifying across these markets allows you to capitalize on different market cycles and better navigate volatility.

• Leverage instruments that can help you manage risk

  • Are we at the bottom yet? I’m sure that this is the question many of us are trying to figure out, and while many data points seem to infer that we are not yet at the bottom, I’ll reemphasize that market timing is extremely difficult and rarely successful. Thus, for those who are looking to take this opportunity to add market exposure, I suggest exploring instruments such as structured products that can help you manage potential downside risk in the current environment.