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Investing Rationally in Turbulent Markets - QUICKTAKE

The stock market sell-off, which began late last week, continued today (Monday, August 5, 2024) with the S&P 500 Index declining approximately 3% by the session’s close. Technology and consumer discretionary stocks were among the worst performers, as investors focused on potential recession risk, especially after last week’s disappointing jobs report.

Impacts from Japan

Negative market sentiment coming into the trading day was reinforced by a number of problematic developments in Japan. The Bank of Japan recently raised its benchmark interest rate to 0.25%. This may seem almost preposterously low from the standpoint of U.S. investors, but it represents a major shift for a country that has been battling deflationary forces for decades.

The BOJ made the decision to boost rates in response to extreme weakness in the Japanese yen and signaled more rate hikes may come. The yen has strengthened significantly in the last few weeks, which contributed to a double-digit sell-off in Japanese stocks overnight (in yen terms). A strong yen will inevitably hurt the earnings power of the large exporters that dominate the Japanese stock market.

There is a technical aspect to these events in Japan, which extends to U.S. markets, which are also widely owned by Japanese investors. So-called “carry trade” investors now face higher borrowing costs and are said to be unwinding positions, which leads to selling pressure on global equities.

Is Kamala damaging investor confidence?

Some Trump supporters are labeling the current market weakness the “Kamala Krash.” The S&P 500 peaked on July 16, 2024, shortly after the assassination attempt on Trump and prior to Biden’s decision to exit from the race. Within the past few weeks, Kamala Harris has emerged as the likely nominee for the Democrats and has received both favorable media coverage and some apparent success in polls.

On July 16, Predictit.org, one of the most followed election prediction platforms, showed an implied 67% probability of a Trump victory. As of August 5, 2024, that figure is down to 50%. The S&P 500 is also down approximately 8% between July 16 and August 5.

While many factors drive global markets, and correlation and causation are often impossible to disentangle, Trump is widely perceived as the more investor-friendly candidate, especially in terms of taxes, energy policy and de-escalating geopolitical tensions. It is reasonable think Harris’ recent rise is contributing to investor unease, especially as another military confrontation between Israel and Iran appears imminent.

Putting the sell-off in perspective

While the recent stock market weakness is concerning, investors should see it in the context of a reversal of strong recent performance. On a year to date basis, the S&P 500 is still up approximately 9%. The recent pull-back has essentially reset index returns to mid-May 2024 levels.

The sell-off appears even more of a non-event when looking at the S&P 500 Equal Weighted Index. The Equal Weighted Index calculates the average performance of each of the 500 constituent stocks and largely eliminates the impact of the largest market capitalization companies (such as the Magnificent Seven tech stocks).

S&P 500 vs. S&P 500 Equal Weighted:

Total Return YTD

On an equal weighted basis, the S&P 500 is merely back to where it was just a few weeks ago. At some risk of oversimplification, what we have experienced over the last three days is an intensification of the recent correction in large cap technology shares. Large cap tech had surged from the end of April to the mid-July market peak, with the Nasdaq 100 Index advancing some 17% in this time frame.

We are also seeing a reversal of the sharp upside that came from the rotation out of large cap tech into smaller companies and other sectors that began in mid-July.

Given that much of the recent drawdown in markets has been led by a handful of rather aggressively valued growth stocks (the Mag 7 are down approximately 14% from the July 16 peak), we do not believe we find ourselves in a particularly distressed environment. In our view, this is neither a moment for panic, nor aggressive bargain hunting.

An opportunity to make adjustments

This breather in the market does, however, create an opportunity for investors to reassess their portfolio diversification and look for opportunities to improve their portfolio positioning.

Investors looking to take advantage of recent pressures on growth and cyclical stocks now have the opportunity to invest at more attractive levels relative to a few weeks ago. Our American Resilience Model Portfolio offers investors a selection of quality growth investment options with relatively cautious valuations, while our Inflation Protection Model Portfolio contains a number of structurally attractive long-term plays in commodity and industrial sectors.

If we do experience a significant deterioration in the growth outlook, as bond markets are currently signaling, stocks that are underpinned by secure long-term cash flows should continue to do well. Our Income Builder Model Portfolio, which focuses on high quality dividend stocks, has outperformed the S&P 500 by approximately 5% since the July 16 market peak. The average dividend yield for the Income Builder portfolio is 4%, whereas the yield on the S&P 500 is now approximately 1.2%.

Market environments like the current one are a good occasion to remind oneself that stock investing works quite well over time, but there will inevitably be volatility along the way. We as always advise a patient long-term perspective, ample diversification across sectors and themes, emphasis on identifying quality businesses with structural tailwinds, and an opportunistic mindset in periods of weakness.  

Click HERE to learn more about all of our Model Portfolio offerings.

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