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What is happening with the investment markets?

Writer's picture: Greg HeathGreg Heath

What’s going on?

Even though the global economy had a strong foundation, there was a sudden 6% decline in equity markets last week, resulting in a decrease of over 8% in US equities since mid-July. The primary cause of this decline was the 20% drop in Japanese equities when measured in yen. On the other hand, bonds experienced a surge in value.


The Why

When the market is ready for a change, even a small trigger can have a significant impact. In recent movements, the main cause has been the unwinding of the yen 'carry trade'.


This type of trading involves borrowing a currency at low interest rates to invest in currencies like the US dollar with higher interest rates, aiming to make 'easy' profits.


However, carry trades are susceptible to foreign exchange rate fluctuations, making them sensitive to currency shocks that may lead to closure when exchange rates move unfavorably. The unwinding of these trades resulted in an almost 11% surge in the yen against the dollar.


The unwinding was set off by a shift in the interest rate outlook, as indicated by dovish statements from the Fed after its monetary policy committee meeting on 31 July, explicitly suggesting the possibility of a rate cut as early as September. The next day, the Bank of England reinforced this notion by implementing its first rate cut in the current cycle, which contributed to a notable weakening of the US dollar.


It is worth noting that global stock markets had been performing strongly so far this year and over longer periods. However, US stocks, especially tech companies, had likely surged excessively and rapidly (rising by more than 37% in eight months). An underwhelming report on US unemployment figures and weak economic surveys on 1 August added to the prevailing unease.


Many investors now believe that this marks the beginning of a cycle of interest rate cuts (often signaling economic downturns) and the start of a shift away from technology and growth stocks towards defensive investments.


How’s it likely to play out?

There are still long-term risks to consider, such as the lack of concern from developed market governments about their continuously increasing deficits, which could potentially result in inflation, as well as the rising geopolitical tensions. It is important to recognize that in the short term, liquidity (and derivatives) have a more significant impact on shaping risk perception today. These factors can sometimes obscure the solid economic fundamentals that are currently in place.


Most Investment houses still hold the same perspective on the structure - that the technology sector, which is propelling US stocks, has not reached its end. While valuations of these companies may be high, their capacity to increase revenue at a faster pace than other sectors should not be overlooked.


Looking beyond the US and the technology sector, we think that stocks are not excessively bought and are not costly, and the outlook remains positive albeit it volatile.


 “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” — Warren Buffett


Sounds like a good philosophy.



Time will tell.



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