International | Sep 04 2024
By Hamilton Wealth Partners
In early August, we experienced the third largest spike in volatility in the past 20 years, as illustrated by the chart below.
(source: Yahoo Finance)
We even had commentators rolling out the little known Sahm rule as a reason.
The Sahm rule is from Former Federal Reserve economist and now chief economist at New Century Advisors, Claudia Sahm. She invented a rule that is claimed to indicate the initial stages of a recession. The rule triggers if the US unemployment rate is 0.5 percentage points or more above its lowest point during the previous 12 months. Earlier last month US unemployment for July hit 4.3 per cent, with a three-month moving average of 4.1 per cent, versus a low of 3.5 in the prior 12 months, thus triggering the Sahm rule.
Claudia Sahm appeared on Bloomberg soon after and she explained why the rule was not indicative of a recession this time.
We need to go back to the beginning of this year to put this volatility into context.
As we entered 2024, the markets predicted seven rate cuts in the US or 1.75 per cent from its current 5.25-5.50 percent range. As inflation proved stickier than many anticipated in the second quarter of this year, rate cut expectations were scaled back to four or 1.0 per cent as many were starting to talk about “no landing” based on robust growth in the US.
Whilst the selloff in the equity markets occurred immediately after the release of the July unemployment data in the US, together with the unwinding of the Japanese Yen “carry trade,” the fact is that the US S&P500 to the end of June had rallied over 14 per cent and was due for a pullback.
The unemployment data and Bank of Japan actions simply provided the excuse. That said, the extent of the selloff was overdone and within weeks the markets again focused on the reality that the next move in interest rates would be down, and much of the selloff was reversed.
This month the Federal Reserve will commence cutting interest rates, the only debate is whether the first cut will be twenty-five basis points (0.25 per cent) or fifty basis points (0.5 per cent), and the market is factoring in a total of 1.5 per cent in rate cuts over the next twelve months.
Many have not participated in this year’s equity market rally or do not trust it. While it is true that the rally in the US has been concentrated in the mega cap technology stocks, we are now starting to see the rally extend to the broader market. We expect this to continue when interest rates start to come down.
Some have been concentrating on Warren Buffett’s offloading of Apple shares or the unwinding of the Japanese carry trade to justify the recent volatility, but often it is just that markets act irrationally.
What we did see in early August was the return of fear, as illustrated by the chart below.
The important thing to concentrate on though is earnings growth, which overall is positive, and the macro environment, where growth is slowing but unlikely to lead to recession, and where interest rates are coming down, outside of Australia.
The table below that our clients would be familiar with clearly illustrates our scenario analysis.
Australia is a different matter altogether. As our Minister for Employment and Workplace Relations proudly stated last week, our wages growth is running well above the inflation rate.
The bottom line is that wage growth inflation is the issue in Australia and as a result it will be much harder to get inflation here back to the 2-3 per cent band targeted by the RBA. We will not see interest rates cuts in Australia before the end of the first quarter 2025 and we may well see US interest rates fall below those in Australia by the end of the first quarter 2025 also.
As a result of this we enter September with our asset allocation position being
Views have varied over the year, and it has been important to rely on fundamentals and where interest rates will be heading. Too many commentators have said the “market is wrong.” We beg to differ.
Diversification has been and will continue to be crucial both amongst and within asset classes. One aspect of markets we do believe is going to be dominant in the next six months is volatility. Strap in for a bumpy ride.
Re-published with permission. Opinions and views expressed are not by association FNArena’s.
Technical limitations
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