What has sparked the recent sell-off in global financial markets isn’t totally clear, in part because one could be justified pointing at a few factors. As of a couple weeks ago, U.S. markets were already up about 20% for the year, though for the most part that performance was concentrated in a small number of stocks. The recent earnings for those companies didn’t surprise to the upside as in past quarters, making a pullback on that news alone not surprising.

Add growing tensions in the Middle East, political noise and some softening in recent economic data and markets were primed for profit taking.

We wrote a short note on Friday that the spark that may have really tipped the balance was weakness in Japan following a tightening in their monetary policy. This change in policy impacted currency markets and has caused turmoil in carry-trade strategies that borrow cheaply in Yen to buy other assets around the world. Since that decision by the Japanese central bank, the Nikkei has experienced record volatility.

The rapid unwind of those strategies puts pressure on a wide range of assets that itself can exacerbate the move in other markets, particularly those that are less liquid (e.g. Crypto). Unfortunately, even if this is the correct identification of the weakness it doesn’t offer insight into how long or extensive this unwind might be.

Importantly, though assets we invest in for clients can be impacted by the moves of traders, the risks to our holdings over time are different. We generally don’t use leverage to drive returns or speculate in currency markets.

We strive to own a large base of quality assets in portfolios and further attempt to manage volatility risk, particularly when we think markets are extended.  Holdings such as U.S. Treasuries are generally much less volatile than other assets and we have extensive holdings of funds with active risk management features. If assets become too extended in our view, we may take the opportunity to trim or sell those positions. In many strategies we trimmed holdings of tech stocks and commodity stocks in June and early July.

Keeping perspective on this move for U.S investors, the S&P500 remains up approximately 10% for the year and is less than 10% from its all-time high. Other holdings, such as gold, are also trading close to all-time highs while Treasuries now are rallying in the face of expected rate cuts on the horizon. We know volatility can be unsettling, especially after extended periods of stability and good performance.  While unpleasant, market declines are a necessary and expected part of investing over the long term.  Historically, while Monday felt very uncomfortable, markets have seen substantially larger moves (March of 2020 where markets were down about 12% in a day source Bankrate).

We expect markets will see more volatility in the coming weeks and months, with the potential for larger daily moves both higher and lower.  Beyond the carry-trade pressures noted, the environment holds many uncertainties for potential international conflict and domestic political developments.

These issues may also feed into economic trends that, as noted, have seen more softening of late.  The recently reported jobs data for July saw the unemployment rate climb to 4.3%, notably higher than the low-to-mid 3% range of a year ago.

We will be closely watching these factors to determine if the trends shift from soft-landing to a more serious recession. Through this process, we would not be surprised to see the Fed become more active and accommodating relative to expectations.

As developments unfold, we will continue to communicate any changes in our view and corresponding implications for client allocations