Global markets were on Monday hit with a bout of severe tumult as concerns swirled over the trajectory of the US economy and traders rapidly unwound bets that have dominated this year.
Japan was at the centre of the late summer storm, with its Topix index tumbling more than 12 per cent in the biggest sell-off since the “Black Monday” crash of 1987. Selling spilled into US and European markets, with Wall Street’s S&P 500 falling around 4 per cent.
What is behind the sell-off?
In short: recent economic data has punctured the widely held view that global policymakers, led by the US Federal Reserve, will be able to cool inflation without too much collateral damage.
Friday’s US jobs report, which showed a much sharper slowdown in hiring than Wall Street anticipated, added to simmering fears that the world’s largest economy is coming under growing strains from high borrowing costs. Corporate executives signalled during the recent earnings season that consumers, who play a central role in the US economy, are beginning to cut back on spending.
“Entering this year, investor expectations were for a ‘Goldilocks’ outcome,” JPMorgan equities strategists said on Monday, adding that this narrative was now being “severely tested”.
Goldman Sachs said at the weekend that it now believed there was a one-in-four chance of the US falling into recession in the next year, compared with its previous forecast of 15 per cent odds.
Signs of impending economic malaise are not limited to the US: eurozone business surveys show the bloc has been hit by geopolitical tensions, weaker global growth and fragile consumer confidence. Activity in China’s dominant factory sector also eased in the three months through to July.
Surveys last month of executives in the manufacturing sector are “consistent with a stall in global factory output gains”, said JPMorgan Chase global chief economist Bruce Kasman.
Japan has further complicated the situation with a continued shift away from its negative-rate policies, which began in March and accelerated last week. This has caused tumult in the currency market that has spread elsewhere.
Why are the ructions so severe?
Global equities markets had up until recently been on the rise, driven by hopes for a Goldilocks economic scenario and a rush into US tech stocks fuelled by enthusiasm for artificial intelligence technology. Wall Street’s S&P 500, the world’s most important equities barometer, rallied almost 20 per cent from the start of the year to a record closing high on July 16.
Pullbacks tend to be swifter than melt-ups: the S&P 500 has fallen more than 9 per cent since reaching its July peak.
The rise in equities this year also made stocks look more expensive, a factor that has been a consistent concern for investors. The S&P 500 was as of Friday trading at about 20.5 times expected earnings over the next 12 months, compared with an average since 2000 of 16.5, FactSet data shows.
The Vix index, often referred to as Wall Street’s “fear gauge”, has shot up to 50 points compared with 16 points a week ago, its highest level since the 2020 Covid-19 pandemic and signalling that more tumult could be in store for markets.
The volatility also comes at the beginning of August, a time when senior investors and traders pack up for their summer holidays. Generally, this “low liquidity” situation lends itself to exacerbated moves.
What is the role of the tech sector?
Many investors have been fretting about the outsized influence on markets of just a small handful of tech stocks — America’s Magnificent Seven.
Apple, Microsoft, Alphabet, Amazon, Tesla, Meta and Nvidia accounted for 52 per cent of the year-to-date returns on the S&P 500 through to the end of July, according to Howard Silverblatt, senior analyst at S&P Dow Jones Indices. These stocks are now under pressure, with their once-positive influence on markets morphing into a pivotal factor in the sell-off. The tech-heavy Nasdaq Composite index is down around 14 per cent from its July peak.
The gloom was accentuated by news this weekend that Warren Buffett’s Berkshire Hathaway cut its stake in Apple by half as part of a broader shift away from equities that led the billionaire investor to offload $76bn of stocks.
Other tech-focused concerns have also surfaced. Intel, one of the US’s best-known chipmakers, tumbled about 30 per cent last week after it unveiled plans to cut 15,000 jobs as part of a sweeping turnaround plan. Other chip stocks fell as a result.
Anxiety that an AI boom would drive huge demand for specialised chips and servers is overdone has also weighed on sentiment.
Chipmaker Nvidia, which briefly became the world’s most valuable company this year, has fallen 35 per cent from its June highs.
Why are Japanese stocks being hit hardest?
Japan’s equities have erased all of their gains for the year following Monday’s plunge, stung by a rapid rise in the yen after the Bank of Japan last week hoisted its main interest rate to 0.25 per cent, the highest level since the global financial crisis in late 2008.
The more hawkish stance in Japan has contrasted with expectations for a dovish shift in US monetary policy. This has caused an unwinding of so-called “carry trades” in which investors borrow in a country with low rates to invest in one with high rates.
This interplay has sent the yen rallying more than 12 per cent against the US dollar — a seismic move in currency markets — since the end of June to ¥142.5. A stronger currency is a big headwind for the country’s exporter-heavy stock benchmarks.
Japan’s actively traded stock market, which is heavily exposed to the global economy, is also an obvious place to start taking risk off the table when big global funds switch into panic mode.
Despite recent bullish “Japan is back” rhetoric, and the all-time highs hit by Tokyo stocks in July, the story only ever had fragile support. Domestic institutions and individuals were never buying into the market with strong conviction, meaning that the heavy lifting of the recent rally was largely driven by foreigners.
It means these investment “tourists” can pull out of the market with extraordinary speed — and they have done so.
Is the US Federal Reserve to blame?
When the Fed held interest rates last week at a 23-year high above 5 per cent, the central bank was doing as investors expected.
But the weak July jobs report, which showed slower hiring and a rise in the unemployment rate, suddenly spread panic that the Fed might have left it too long to begin lowering borrowing costs, heightening the risks of a US recession. Fed chief Jay Powell may be put to the test if markets begin creaking over a sustained period.
Markets are now pricing in 1.25 percentage points of Fed cuts — or five quarter-point reductions — by the end of the year. Traders are also betting on the possibility the US central bank will be forced to react before its next meeting in September with an unscheduled emergency cut.
“We see a possibility of a [0.5 percentage point] cut in September but want confirmation from other data,” said Steven Englander at Standard Chartered. “If other data confirm that the decline is as steep as the July labour data suggest, a sequence of sharp cuts is likely.”
Additional reporting by Leo Lewis
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