A rumble, a tumble, and a recovery

Markets had a bad start to the new month – with indices in the US, Europe, and Japan all having some of their worst days in years. Why did this happen? Here’s a deepdive.

 

Big tech

First of all, there had been concern for a while about the valuations (share prices) of the big US tech companies, particularly those focused on artificial intelligence (Apple, NVIDIA, Microsoft, Alphabet).

Those companies have attracted a lot of investors over the last 24 months and concerns are rising on whether their share prices accurately reflect the companies’ future prospects – or whether they’re in a ‘bubble’.

 

Rate cuts (or lack of)

Secondly, the markets have been anticipating interest rate cuts in the US all year which have not happened. The US Central Bank (The Federal Reserve) opted on 24 July to not cut interest rates – but have since signalled that they will likely cut in September 2024.

Almost immediately, data came out to suggest the US economy was not performing particularly well, culminating in very underwhelming jobs data on 2 August. So, the concern is the US has kept interest rates too high for too long, which could lead to a recession in the future.

This combination has led to some investors selling stock and taking profits. It’s important to note that the US market fall only took share prices back to where they were in June 2024. If someone had said to you back then that markets would be flat for the next couple of months, you would’ve probably shrugged your shoulders.

 

The yen

Thirdly, the Bank of Japan took the surprise decision to increase interest rates to 0.25% on 31 July – the highest level in Japan since 2008. This increased the value of the yen, and a rising yen automatically depreciates the share prices of Japanese companies because many of the country’s largest firms, including Hitachi, Sony, and Toyota, make their earnings overseas in foreign countries.

This explains some of the decline in Japanese stocks. The rest of the explanation can be found in the unwinding of a popular trade linked to a weak yen. This trade is known as a ‘carry trade’ and it allows investors to borrow yen cheaply, convert it into a foreign currency with a higher interest rate (US dollars), and invest in assets that generate higher returns than the rate of interest on the initial loan in yen.

When the yen increased in value on the back of rising interest rates, this trade instantly became unattractive – which led many investors who were participating in it to unwind their positions. This meant that they dumped more yen into the market and sold some of the assets they’d purchased using the cheap loans to cover the increased cost of borrowing on the back of higher interest rates on the yen – exacerbating the problem.

 

What does this mean for you?

Well, not much. Markets have largely rebounded since the initial drop at the start of August. The S&P 500 was up 3.7% between 1 and 30 August, the FTSE 100 was up 1.13%, and the Nikkei 225 (Japan’s main market index) was up 1.37%. Here’s the Nikkei’s performance visualised over the past six months – you can see the drop on 1 August, and the post-drop recovery to end the month 1.37% up on where it started.1

 

 

If we also look at the US, the S&P 500 had its best day since 2022 on 8 August and recovered all but 0.5% of its loss from the start of August. Other major US indices also went up on the same day – the Dow Jones Industrial Average increased by 1.8%, and the Nasdaq shot up 2.9%.2

And then a week later on 15 August, the Dow Jones increased 1.4% and the Nasdaq jumped up 2.3% on the back of encouraging consumer and labour data that helped reduce worries of recession. The S&P 500 also closed up on the same day, rising 1.6% for its sixth consecutive daily increase.3

This puts into perspective what we should all know as investors – there will be ups and downs, and it can feel like the market will go down forever when we’re in a period of decline. This feeling can be made worse by news stories and headlines, which tend to put more weight on negative news when it comes to markets.

If you’re interested in markets, it can be useful to understand what moves investments in the short run – but it’s also a completely reasonable and sensible strategy to ignore short-term noise. In reality, nothing that happens in the market should impact your financial plan – and if you’re investing for five years or more as you should be, these short-term market movements are part of the journey.

 

1 Google Finance, 1 August – 30 August, 2024

2 Google Finance, 8 August 2024

3 Google Finance, 15 August 2024