At Naked Finance, we're keenly aware of the shifting landscape in the global financial markets, and our mission is to help you navigate these changes with confidence. Recently, we've witnessed a surge in market volatility across various asset classes including equities, bonds, and currencies. In this blog, we'll break down what's been happening, why it’s happening, and how you might consider positioning your investments during this turbulent period.
What's Driving the Recent Market Volatility?
The recent volatility may feel sudden, but it's the result of underlying factors that have been building over the past few years. Here are the three main drivers:
Tech Sector Skepticism and the AI Hype:
The tech sector, particularly companies invested in artificial intelligence (AI), has been a major focus for investors over the last 18 months. While there’s excitement about AI’s potential, recent skepticism has emerged regarding the revenue these investments can generate. A report from Goldman Sachs, for instance, raised questions about whether these companies will see substantial returns in the near term. This uncertainty has led to a cooling off in tech stocks, which have been a major component of global market indices.
Concerns about the US Economy:
A weaker-than-expected jobs report in the US, with unemployment ticking up to 4.3%, has sparked fears of an impending recession. Historically, rising unemployment can lead to a downward economic spiral, as job losses reduce consumer spending, which in turn affects corporate revenues and can lead to more layoffs. However, while recession risks are indeed increasing, it’s important to note that this doesn’t necessarily mean a sharp economic downturn is imminent. The US economy appears to be gradually slowing, but there are no signs of the overinvestment or excessive leverage that typically precede a severe recession.
The Impact of Japan’s Monetary Policy:
The Bank of Japan’s recent interest rate hikes—for the second time this year and the first in over 17 years they have started on an interest rate hiking cycle—have had significant ripple effects. Japan has been an important player in global carry trades, where investors borrow in yen (due to historically low interest rates) to invest in higher-yielding assets elsewhere. As Japan raises rates, the yen strengthens, and the profitability of these carry trades diminishes, leading investors to sell off assets in other markets, including US equities. This dynamic has contributed to the broader market sell-off we’ve observed.
What Does This Mean for Your Investments?
Understanding these drivers is crucial, but the key question is: how should you position your portfolio in response?
Equities: The sell-off in US shares has led to a roughly 10% decline—a correction that’s not unusual, but still significant. The key is whether this correction will deepen. The tech sector’s high valuations have been underpinned more by expanding multiples than by earnings growth, which means there’s limited valuation support to halt further declines. For now, it may be wise to be cautious with equities, particularly in sectors that are still trading at high valuations relative to their earnings growth.
Bonds: Bonds have traditionally been a safe haven during equity market volatility. Recently, the US 10-year Treasury yield fell to its lowest level in over a year but has since rebounded. However, with the ongoing fiscal support in the US and expectations of future rate cuts still in the air, bonds may not provide the same cushion against equity market volatility as they have in the past. We’re trimming our bond positions and relying more on derivative strategies to hedge against further market turbulence.
Currencies: The currency market has also been volatile, with particular attention on the Japanese yen and its effects on global markets. Meanwhile, the New Zealand dollar has seen movements influenced by domestic factors, such as the Reserve Bank of New Zealand’s monetary policy stance and recent employment data. Despite a relatively stronger Kiwi dollar recently, we expect it to face downward pressure as global risk sentiment remains fragile. Positioning in currencies should be done carefully, considering both global and local factors.
Looking Ahead: Stay Vigilant
We’re in a period of heightened uncertainty, and while market corrections can be nerve-wracking, they also offer opportunities for the well-prepared investor. It’s crucial to stay informed, be flexible with your strategies, and not overreact to short-term market moves.
At Naked Finance, we’re here to help you make sense of these changes and adjust your portfolio to suit your long-term goals. Feel free to reach out with any questions, or if you’d like to discuss how these market dynamics might impact your investments.
Stay informed, stay invested, and stay on top of the markets with Naked Finance. Reach out to the team today.
For further details on the topics discussed, you can refer to resources like Goldman Sachs' recent research on AI and US labour market data. Keep an eye on updates from the Bank of Japan for insights into their evolving monetary policy.
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