A Turbulent Week for the Stock Market

Quick Take

• Stocks dropped to start the month of August. After a year of relative calm, the S&P 500 fell 5.6% from its recent high. Technology stocks and the Japanese market declined more severely.

• While a sudden change the market can be jarring, pullbacks or corrections of this magnitude occur frequently. Avoid reacting drastically to these moves, be strategic, and trust your long-term plan.

After calm for most of this year, turbulence hit the financial markets this month. The S&P 500 fell 5.6% from its July 16th high. The selling intensified on Thursday, August 1st, with the S&P 500 dropping 3.8% in two days. Selling pressure hit tech-heavy NASDAQ harder as it dropped over 10% since its peak on July 10th. Though Japanese Nikkei stock index, which fell 12.4% on the following Monday, experienced the biggest 1-day decline in Japan since 1987. It can be unnerving when the stock market appears to turn suddenly. Leaving many to ask: is this a typical pullback or the sign of something more serious?  

Investors have flocked to US Treasuries in a typical flight to quality fashion. The yield on the 10-year Treasury fell to 3.78% before rebounding back to 4%. The monetary policy-sensitive 2-year Treasury yield fell even further, anticipating more interest rate cuts. 

There has been speculation about what is behind the sudden volatility. Some pointed to the Federal Reserve's decision not to cut interest rates last Wednesday and a weaker jobs report on Friday. The implication was that the Fed is behind the curve on cutting rates, creating a greater risk of a hard economic landing. 

The fact that Japanese market is at the epicenter of the storm suggests something other than the economic data exacerbated the move. Some investors, most likely leveraged hedge funds, borrowed money in Yen, where interest rates are low, and bought Japanese and US technology stocks.  A sudden move against these investors forced some quick liquidations. The acuteness of the selloff and the fact that it was most severe in the Nikkei suggest this was driven by extreme positioning. 

While there is some evidence that economic growth is moderating, the economy is still expanding at a healthy clip. The Atlanta Fed GDPNow forecast suggests inflation-adjusted GDP growth is tracking 2.9% this quarter. The increase in the unemployment rate to 4.3% from 4.1% in the last month may be due to temporary weather-related factors.

Despite notably weaker earnings reports from Google, Apple, and Amazon, corporate earnings have generally been better than expected, with 78% of reporting companies beating analyst expectations for the second quarter.

No one knows why the stock market suddenly moves on any given day. When asked what the stock market would do, the venerable J. Pierpont Morgan is believed to have said, "Stocks will fluctuate." That may be all we can say from day to day. Occasionally, financial excesses—over-optimism, too much leverage, and other mistakes—can wreak havoc on markets. History suggests these types of moves vary in size. For now, this looks to be a benign and typical correction after a good run in the market. 

Still, in a year of relative calm and strong stock market returns, a sudden change in tone is jarring.  Over the long term, prudently diversified investors have been rewarded for withstanding these price swings.

Here is what we are focusing on during this bout of volatility:

• Avoid reacting to sudden moves. Trading on volatile days can be more costly as bid and ask spreads typically widen. Where needed, we look to take the liquidity that markets may provide in safe-haven assets.

• Look to harvest tax losses while being careful not to exit the market or violate wash-sale rules.

• Invest cash for those who are looking for long-term entry points.

• Consider long-term tax strategies like Roth conversions at depressed prices.

Five or ten percent pullbacks in the stock market occur frequently, and there is usually a ten percent correction every year or so. While market conditions may influence some decisions, it's essential to be strategic and methodical and trust your long-term plan.

We are available to discuss your situation further. 

Contact us at 865-584-1850 or info@proffittgoodson.com

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