Why Global Financial Markets Are in Extreme Flux

by AGF Investments' Investment Management Team, AGF Investments

Members of AGF Investments’ investment management team weigh in on the heightened volatility that is currently roiling stock, bond and currency markets around the world.

John Christofilos, Chief Trading Officer

The selloff in global equity markets over the past few days has been precipitated by a confluence of reasons that include growing recession fears following weaker-than-expected manufacturing and employment data in the United States late last week. Other headwinds at play are growing geopolitical tensions in the Middle East and Warren Buffett’s decision to sell one half of his firm’s stake in Apple Inc., which may have influenced other market participants to take profits in some of their holdings as well. Historically, this time of the year also tends to be seasonally weak for stocks, but perhaps the biggest factor in causing the selloff was the unwinding of Japanese Yen carry trades, which forced many investors to sell other assets to avoid losses.

If anything, it’s unclear how long this current bout of heightened volatility will last, yet we’ve seen global equity markets correct this violently before and never in the past have they not eventually rebounded to new highs.

David Stonehouse, Head of North American and Specialty Investments

U.S. economic activity has clearly decelerated in recent months, but in our view the bond market rally may be overextended. Business activity remains positive and the internal employment data looks more resilient than the headline unemployment rate. At one point on Monday, the equity market was pricing in multiple 50 basis point rate cuts from the U.S. Federal Reserve (Fed), which seems an overreaction.

Notably, the U.S. 2-year Treasury yield erased all its declines on Monday, climbing 30 basis points from intraday lows. Volatility may subside from very high levels, but it may be premature to sound the all-clear.

Going forward, the focus from a fixed income and currency perspective will be on economic data (two U.S. inflation prints and another jobs report before the Fed’s next meeting), the Jackson Hole central bank symposium in late August, and currency movements (particularly the Japanese yen compared to key counterparts including the U.S. dollar, Mexican peso and Australian dollar).

Auritro Kundu, Portfolio Manager

Global technology stocks have been among the hardest hit during the selloff to date, in large part because investor confidence in artificial intelligence (AI) spending has waned following recent quarterly results. The S&P 500 Information Technology (IT) Index experienced a 7% decline over the past week, driven by Semiconductors subgroup (-10%) and AI-related Infrastructure stocks (-8%).

Additionally, U.S. equity investors are closely monitoring consumer stocks amid labor market uncertainties. The S&P 500 Consumer Discretionary Index saw a 9% decrease last week, making it the sole S&P 500 index sector with a negative year-to-date return (-3%). Despite the market selloff, the S&P 500 Index remains approximately 9% higher than it did to start the year.

Historical analysis reveals that purchasing the S&P 500 Index after a 5% decline yields a median 6% return over three months, with an 84% success rate, as reported by Goldman Sachs. While corrections of 10% are also appealing, their success rates historically have been lower.

Stephen Duench, Portfolio Manager

The significant rotation from large capitalization stocks to small capitalization (and from growth stocks to value stocks) that we saw in July has been one of the casualties of the selloff in recent days. In fact, we’ve seen capitulation across all these assets in favour of the most defensive areas of the equity market.

While several factors are at play, trading volumes have been driven heavily by large systematic traders “de-grossing” their equity exposure, which, all things considered, has only contributed to the large spike in volatility that we’ve witnessed over the past few days.

The Volatility Index (VIX) is now at levels that in the past have typically pointed to better times ahead. Moreover, the VIX curve recently inverted, meaning current volatility is much higher than the volatility expected three months from here. This is a rare occurrence that, based on our research, has coincided in the past with positive equity returns three months or more after it happens.

Andy Kochar, Portfolio Manager

It seems like Japan is having its own “1987-moment” thanks to the unwinding of the Japanese Yen carry trade. Reminiscent of the Black Monday selloff that happened 37 years ago this October, the Nikkei 225 Index fell close to 20% in just two days and before rallying today was down 26% peak to trough since mid-July, largely because of investors needing to unwind a variety of carry trades which includes investment grade, high yield, and syndicated bank loans.

The heightened volatility is a reminder to market participants of the unintended consequences of divergences in the trajectory of monetary policy between the Bank of Japan and rest of the developed world. Fortunately, we believe this technical repricing allows for more normal valuations to reappear in what is fundamentally a structurally sound market for active management.

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.

Apple Inc. is a current holding in AGF Investments portfolios as of June 30, 2024. The information contained herein is designed to provide you with general information. It is not intended to be comprehensive investment advice applicable to the circumstances of a particular investor. References to specific securities are presented for illustration purposes only and are not to be considered recommendations by AGF Investments. It should not be assumed that investments in the securities identified were or will be profitable.

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