Market Update: 6 August 2024
Recent Market Volatility and Economic Fundamentals
In recent weeks, financial markets have been a rollercoaster of volatility, with U.S. markets experiencing significant fluctuations and a recent sell-off. While on the surface these are big movements, its important to understand these in the context of exceptionally strong market performance earlier in the year that saw the Nasdaq gain over 30% in value on the back of strong forecasts from technology, and specifically AI-related securities. Following the recent correction, the Nasdaq still stands at around 20% returns for the past year, well above its long-term average.
The adage that when the U.S. sneezes, the world catches a cold remains pertinent. Australian markets are not immune to U.S. stock market tremors, and we have seen early signs of in the short-term return data in the coming weeks for local equity markets. Asian markets similarly saw sell-offs, with Japan the heaviest hit losing over 10% in a single trading day.
Looking past the short-term volatility, fears over the real economic strength of the US economy have been widely cited as the reason behind the recent pessimism. However, capital markets are more than just a prediction of recession: they are heavily impacted by changes in expectations, even when those expectations are in the backdrop of a benign economic environment.
Balancing employment and intervention in the US economy
The latest U.S. job data revealed an unemployment rate climbing to 4.3%, which was higher than expectations. This uptick in unemployment has stoked fears of an economic slowdown, prompting speculation about a potential 50 basis point rate cut by the Federal Reserve. Reflecting these concerns, yields on 2-year U.S. government bonds have dropped sharply, signalling market expectations that the Fed might intervene to cushion the economy and ensure a soft landing while keeping inflation in check.
Australia: Stability Amid Global Uncertainties
Contrastingly, Australia’s economic situation appears more stable. The jobless rate here mirrors the U.S. at a superficial level but has shown remarkable resilience, primarily buoyed by steady immigration numbers. Currently, there is little expectation of a rate cut from the Reserve Bank of Australia (RBA), highlighting a divergence in monetary policy responses between the two nations.
Investing for the long term
For investors, these are instructive times. While recent market turbulence has certainly been jarring, it is essential for investors to distinguish between short-term market movements and the underlying economic realities. Period sell-offs in equity markets are normal, especially when the valuation levels of broader indices start to reach dizzying heights and become unsustainable. As an example, NVIDIA, the darling of the tech rush, earlier in the year reached a valuation of over 140x earnings, well above its 18x earnings long term valuation level. This spike in valuation briefly lifted NVIDIA to being the biggest company in the world, above Apple. No such lofty valuation levels exist within the Australian majors.
Published 6/8/2024
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