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We have seen the market sell off precipitously the past week or so. The Nasdaq Composite Index, which is home to the large-cap stocks that have done so well, has declined over 13% from its high. Nvidia, which has been the posterchild for the explosive artificial intelligence (AI) trade, is down from its high of $140 to a low of $91. So what’s going on and how concerned should we be?
Ten percent market corrections, while painful, are normal.
There have been 11 significant declines of 10% or more in the S&P 500 over the past 20 years. Approximately once every 6 years, we have a decline of over 25%. The market (S&P 500) is up approximately 350% in that same time frame. Volatility is the challenge we face to get higher rates of return.
That being said, we don’t want to be complacent and just assume the markets will recover without further significant declines.
There are many factors that have led to the current sell off. I will highlight the most obvious.
1) Outsized performance from tech companies benefitting from the development of AI. Stocks don’t go straight up forever. The market is repricing these companies. Ultimately, we believe many of these companies (Nvidia, Amazon, Microsoft, Apple, etc.) will go higher - significantly so.
2) Recession fears. The jobs number last week was significantly lower than expectations. In an effort to slow the rate of growth in inflation, the Federal Reserve has been raising rates. The goal of these increases is to slow the economy. The question is whether they can slow the economy without putting the economy into recession. History tells us that is unlikely. The July jobs number could be misleading. The hurricane in Texas is one factor that may have led to a lower number. August will give us a better read.
With those factors as a backdrop, the Japanese financial markets (Nikkei) crashed 13% over the weekend. This leads us to the third issue.
3) The unwind of the Yen Carry Trade. Simply put, the Bank of Japan waited too long to raise rates. Now they are beginning to act. Many institutions have been borrowing the Yen at low interest rates and converting that to US dollars or other currencies to take advantage of higher interest rates in other countries. Now, not only must they pay higher interest rates for the Yen they borrowed, they are now facing large foreign exchange losses as well. The US stocks they are holding may not be enough to repay the Japanese Yen they have borrowed. This is causing a huge unwind of these trades. Traders and hedge funds facing big losses and margin calls are forced to sell their U.S. equities and other assets. I've linked a video here with an insightful 90 second explanation of the Yen Carry Trade. Click here to watch video.
4) Crisis of Confidence. There is a leadership void. Who is the President? Moreover, many believe there has been an orchestrated cover up at the highest level. This has led investors to start questioning what they can or cannot believe. The tightening in the Presidential polls has led to increased investor anxiety. Raising the capital gains tax and corporate tax rate does not assuage investor fears.
As bleak as all that sounds, the good news is the biggest change in the market is based more on a change in sentiment rather than broken fundamentals. We have exceeded expectations for the market this year up until now. August is typically a dicey month and September is usually down. The market will continue to be volatile we believe over the next few months. However, we think the markets will close the year higher and, more importantly, we believe great companies go higher over the long run. Declines are temporary!
We work every day to make the best decisions for our clients. We are passionate about our work and value the trust you place in us.
We will be fine.
AP
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