Summer sales – both in shopping malls and at bourses – are always a tricky thing. For you never know whether your favoured item will become even cheaper eventually. The ‘pros’ call this a Dutch auction. A Dutch auction starts at a very high price level and moves down until the buyers come in. So some stock markets hit an all-time high in mid-July and have been in Dutch auction mode ever since. It is just a question of time until the bidders come in – but will it need even lower prices or much lower prices for that?
Where do markets go from here?
Before we answer that question, let us look at the drivers of the sell-off. First, there were some exuberant expectations about the new economy leaders, especially the ones related to artificial intelligence. We argue that the topic is by no means over and done with. However, with earnings estimates sky-rocketing, it became harder and harder for market leaders to meet them, so they sold off and stock indices followed.
After that, the macroeconomic numbers in the US – the stronghold so far and the largest economy in the world – started to come in way below expectations. Some leading indicators are approaching recession levels, and the lagging indicators of the US job market are flashing softness too. When markets are in summer sale mode, it is futile for us to point out that the softness in US jobs is mainly due to more people joining the labour force instead of lay-offs going through the roof.
And it is also futile for us to highlight that our estimate of the probability of recession has only risen to 25% (from 15%). Rather, the rout accelerated last week, taking the Japanese Yen (JPY) with it. The JPY was the funding currency of choice for global leveraged positions (aka the ‘carry trade’), and the unwinding triggered the next cascade.
Given the current set-up, it remains to be seen whether the rout stops here or whether the unwinding of carry trades triggers some further collateral damage. Speaking of ‘known unknowns’, we have not even mentioned US elections, geopolitics in the Middle East, or potential further seasonal weakness. Let us instead just conclude by saying that the flashing buy signals are better left to extremely agile investors such as traders, while all other investors would be wise to look for opportunities after the situation has stabilised, which may mean in weeks rather than days.
What does the equity market mean for investors? Stay calm for now
Our view has been for some time now that equity markets were ripe for a near-term correction given the elevated positioning and optimistic earnings expectations. Nevertheless, the fast-paced cascade move in equities has surprised us too. As we still believe that the current batch of soft data in the US marks a temporary pause in the ongoing economic recovery rather than the start of a recession (to which Julius Baer Research attaches a 25% probability), we recommend investors to remain calm for now.
Real-time data on the US economy still paints a solid picture, while US companies overall delivered good results in the second quarter despite rather ambitious expectations. As such, we view the recent moves as an intermediate correction in a primary uptrend in the secular bull market. Although single pockets of opportunities are emerging, continued recession fears will likely result in better buying opportunities for the broad equity market in the near future.