In the last few days, we have witnessed a significant drop in the value of stock markets around the world. The sell-off started with the US publishing weaker employment numbers on Friday (2 August), which sparked renewed recession fears.
This was compounded by geopolitical worries in the Middle East, with the possibility of an escalation of hostilities from Iran following the killing of a Hamas leader in Tehran.
In addition, announcements from US-based companies about their current and predicted quarterly earnings, have been disappointing. The unexpected decision by the Bank of Japan to raise interest rates created further instability, all at a time when stock valuations are particularly high.
In this article, we’ll examine each of these factors in more detail and assess their impact on the market and the economy. We will also discuss some potential scenarios and strategies for investors to consider in the current environment.
Weaker employment numbers
On Friday 2 August, the US Bureau of Labor Statistics reported that the economy added only 114,000 jobs in July, well below the consensus estimate of 194,000 and the number that was revised down from June. The unemployment rate crept up to 4.3%, the highest number since 2021. The weak numbers raised concerns about the pace and sustainability of economic growth, especially in a higher interest rate environment.
Our view: While there is an indication of a slowing economy, we think there is no compelling evidence that we are entering a recession. Unemployment is still very low, and some of the increase in joblessness can be attributed to an increase in retired people choosing to return to the workforce, but who are struggling to find employment.
Geopolitical concerns
Last week, a political representative of Hamas, Ismail Haniyeh, was killed in Tehran, while Fuad Shukr, a senior Hezbollah leader, was killed in Beirut. Iran accused Israel of being behind the attack on its soil and vowed to retaliate. Hezbollah also vowed to avenge the death of its leader. The incident has heightened tensions in the region and increased the risk of a wider conflict that could disrupt oil supplies and global stability. The market reacted negatively to the news, as oil prices spiked and “safe haven” assets such as gold and bonds rallied.
Our view: In the last few days, there have been indications that Iran does not want a full-scale confrontation with the West, and the general view is that any response will be fairly muted.
Earnings season
The second-quarter earnings season is well underway, and the market has taken a glance at overall market performance. So far, the earnings have been mixed, with the percentage of companies beating market expectations being below the long-term average.
The market has been sensitive to any signs of weakness or uncertainty in the corporate sector, reflecting the challenges posed by AI investment. The technology sector is a worry for many investors, as the growth of average earnings-per-share without NVIDIA (a US microchip manufacturer) would be only 6.8%. This is far from the double-digit growth these companies have been accustomed to providing.
The market has also been adjusting its expectations for future earnings growth, as the effects of AI seem further away.
Our view: The earnings season, while not exceptional, is positive. In a long market rally with new technology, it should be expected that quarter-on-quarter results are sometimes less than impressive. In the long term, we believe that technology will be supportive of markets.
Valuation
Another factor that contributed to the sell-off was the high valuation of the stock market. The S&P 500 index was trading at a forward price-to-earnings ratio of 21.3 as of Friday, well above its historical average of 15.8. The market was vulnerable to a correction, as any negative news or uncertainty could trigger profit-taking or risk-aversion behaviour among investors. The market was also facing some technical pressures.
Our view: We have seen valuation as a clear headwind for investors who have always been cautious around expensive valuations. However, if the US is expensive, other regions are offering very interesting valuation levels. We think there are great companies whose valuations are not fully reflective of their true worth, with the UK being one of those attractive regions. The recent sell-off does not reflect how cheap some stocks currently are.
Monetary policy
Monetary policy is in flux, with the Bank of Japan raising interest rates unexpectedly, creating some tension in trading activities in the Japanese yen. Many think that the US Federal Reserve and the Bank of England have been too cautious in their approach to cutting rates.
Our view: Monetary policy has been very restrictive for the last two years, yet it didn’t have a great impact on growth or market activity. It is wise to be aware of it, but not to overstate its impact.
Our advice for investors
Firstly, don’t overreact: During a market sell-off, a common reaction is to sell everything and run for the hills! But we should remember that investing always carries some risk. Seeing a market re-pricing is not an out-of-the-ordinary phenomenon. Therefore, we should leave emotion out of it.
Secondly, stick to your investment plan: At the outset of your financial journey with your adviser, we prepared for every eventuality. A market correction is very much a part of these stress-tests. If we stick to the agreed long-term plan, we are more likely to achieve your financial goals.
Finally, don’t try to time the market: Market-timing is notoriously difficult, and the reward-risk relative to the amount of effort required, is generally not worth it.
Conclusion
We see this market sell-off as a complex and dynamic phenomenon driven by multiple factors. We regard it to be a healthy behaviour for the market. So far this year, we have not experienced any kind of sell-off, which has lured investors into a false sense of security, leading to pumped-up prices in speculative assets.
For investors, this is a time to remain calm and collected. A well-diversified and balanced portfolio will help weather the market storm and leave you better off when the volatility has abated. Your financial advisers should be your first point of contact to help you navigate this environment.
