The first half of the year saw the market on a generally positive trajectory, with the S&P 500 reaching a peak on July 16th, up approximately 18.5% for the year. However, since that high, the market has faced significant volatility, with the S&P 500 experiencing sharp swings and the VIX—a key measure of market volatility—surging to its third highest level ever, behind only the Great Financial Crisis and the early days of the COVID-19 pandemic.
This recent volatility can be attributed to several factors, including rising unemployment, soft economic data, and heightened price fluctuations, all of which have intensified fears of a broader economic slowdown. The combination of these elements has created an environment of uncertainty and market turbulence.
In this blog post, we’ll explore these contributing factors in more detail and offer insights on why maintaining a long-term perspective remains crucial for investors.
Weak Labor and Manufacturing Data
Last week, the Bureau of Labor Statistics reported underwhelming jobs data that fell short of market expectations, adding only 114,000 jobs in July compared to the anticipated 175,000. Additionally, the unemployment rate edged up to 4.3% from 4.1%[1]. A weakening labor market with a rising unemployment rate often serves as an early warning sign of a potential recession. This disappointing labor data was further compounded by a significant drop in manufacturing activity, with the ISM Manufacturing Index declining to 46.8 in July from 48 in June—a reading below 50 indicating industry contraction.
These figures have sparked concerns that the Federal Reserve might be too late in adjusting interest rates to prevent the economy from slipping into a recession. The combination of rising unemployment and a shrinking manufacturing sector is certainly alarming.
However, there’s more nuance to the story. According to a research note by Jim Paulsen, the increase in unemployment is not primarily due to layoffs. Instead, it’s driven by new entrants expanding the labor force. Since January, the number of unemployed has increased by approximately 1.039 million, while the labor force has grown by 1.153 million. This suggests that the rise in unemployment is more about the influx of workers rather than widespread job losses[2]. Historically, the labor force has tended to contract ahead of a recession, which is not the case right now. Additionally, jobless claims data from the Department of Labor on August 8th showed a decrease, with first-time filings for unemployment benefits dropping to 233,000—a decline of 17,000 from the previous week and lower than the Dow Jones estimate of 240,000[3]. Lastly, a research note by Tom Lee with FS Insight noted some economists believe the disappointing jobs data may have been skewed by Hurricane Beryl in Texas[4].
While the labor market is undoubtedly slowing, it does not yet appear to be flashing the typical signs of an impending recession.
Unwinding of Popular Japanese Yen Carry Trade Strategy
The yen carry trade, a long-favored strategy due to Japan’s persistently low-interest-rate environment, has recently added to market turbulence. This strategy involves borrowing in a low-interest-rate currency like the yen to invest in higher-yielding assets. By capitalizing on the interest rate differential, investors have been able to generate substantial returns. However, the recent surge in inflation and a surprise interest rate hike by the Bank of Japan (BoJ) have upended this popular trade.
As the yen appreciated rapidly over the past few weeks, many investors were forced to unwind their positions. The scramble to sell off assets and buy yen to cover the short side of their trades, further amplified the market volatility. Although the exact scale of the carry trade is difficult to pinpoint, estimates suggest it could range between $1 and $4 trillion. Reports indicate that around 75% of these trades have already been unwound[5].
In response to the market upheaval related to the yen, BoJ Deputy Governor Shinichi Uchida reassured investors by signaling that the central bank would be cautious about raising rates further if market instability persists[6]. This statement has helped ease some fears of broader contagion. Following a sharp decline of over 17% from its year-to-date high on July 10th, the Nikkei has shown signs of stabilizing, indicating that the Japanese market may be finding its footing after the recent turbulence.
Market Seasonality
August has historically been a favorable month for markets during election years. However, when the S&P 500 sees gains of over 10% in the first half of the year, August returns have a tendency to falter. Tom Lee and his research team at FS Insight analyzed S&P 500 returns dating back to 1950 and found that when the market is up by more than 10% in the first half of the year, August often experiences a cooling-off period. Specifically, in 23 instances where the market had such strong first-half gains, the average return in August was -0.06%, with a positive win ratio of 39%. This contrasts with an average return of 0.5% and a 54% win ratio for August across all periods[7].
Despite this historical trend, we remain optimistic about overall market performance for the remainder of the year. Lee’s analysis also showed that when the market is up by 10% or more in the first half of the year, the second half tends to deliver solid returns. In those 23 instances, second-half returns averaged 9.8% with an 83% positive win ratio, compared to a 5.6% return and a 72% positive win ratio for all years since 1950[8].
Positive Market Indicators
Despite the recent volatility, there are still several positive indicators related to interest rates, consumer health, corporate earnings and economic growth.
Dovish Federal Reserve and Interest Rate Cuts
The Federal Reserve is anticipated to begin cutting interest rates in September, a move that could have positive implications for market valuations and borrowing costs. Current projections suggest the Fed could implement anywhere from one to five rate cuts by the end of the year. Lower interest rates typically benefit stock valuations by making borrowing cheaper for both businesses and consumers. This reduction in borrowing costs can stimulate economic activity, leading to increased corporate profits.
Healthy Consumer
Consumers remain in good financial shape, supporting economic stability. Consumer spending is a major driver of the U.S. economy, accounting for about 70% of GDP. Indicators such as retail sales suggest that consumers are still spending, which bodes well for economic growth.
Positive Corporate Earnings
Corporate earnings are a critical gauge of market health, and despite recent volatility, many companies have posted strong results. With over 75% of companies having reported their second-quarter 2024 earnings, year-over-year growth is trending at 11.5%. If this figure holds, it would represent the strongest quarterly earnings growth since Q4 2021[9]. This resilience suggests that businesses are effectively navigating current challenges and sustaining profitability, which bodes well for long-term investors.
Looking ahead, analysts are forecasting earnings growth of 14.8% and revenue growth of 6.0% for 2025[10], further reinforcing the positive outlook for corporate performance.
Positive GDP Growth Estimates Amid Weak Reports
Recent economic reports have been lackluster, but the Federal Reserve Bank of Atlanta’s GDPNow forecast for the third quarter (as of August 8th) still points to a 2.9% growth rate[11]. Although this figure may adjust as the quarter progresses, the economic growth projections for 2024 remain positive, indicating continued expansion. This suggests that, even with current challenges, the economy is on track to maintain its growth trajectory.
Conclusion
While recent market volatility has been influenced by a range of factors—from weak labor and manufacturing data to the unwinding of the yen carry trade—there are several positive indicators that suggest a promising outlook for the future. The Federal Reserve's anticipated interest rate cuts could boost market valuations and economic activity, while strong corporate earnings and healthy consumer spending further support a positive economic trajectory. Despite August’s historical tendency for cooling-off periods and short-term fluctuations, the overall long-term outlook remains encouraging.
Investors should recognize that market volatility is a natural component of the investment landscape, often providing opportunities for revaluation and future growth. By focusing on long-term goals and understanding the broader economic context, investors can better navigate current uncertainties and position themselves for sustained success.
[1] "July Jobs Report: Latest Updates and Analysis." Barron's, July 2024. https://www.barrons.com/livecoverage/july-jobs-report-today.
[2] Paulsen, Jim. "Unemployment, Recession, Soft Landing." Paulsen Perspectives. Accessed August 9, 2024. https://paulsenperspectives.substack.com/p/unemployment-recession-soft-landing.
[3] "Weekly Jobless Claims Fall to 233,000, Less Than Expected, in a Positive Sign for Labor Market." CNBC, August 8, 2024. https://www.cnbc.com/2024/08/08/weekly-jobless-claims-fall-to-233000-less-than-expected-in-a-positive-sign-for-labor-market.html
[4] Lee, Tom. "Evidence Growing That Equities Made Their Summer Lows on 8/5 Weekly Claims." FS Insight, August 9, 2024. https://fsinsight.com/macro-strategy/first-word/2024/08/09/evidence-growing-that-equities-made-their-summer-lows-on-8-5-weekly-claims/
[5] LPL Research. "A Deeper Dive into the Carry Trade." LPL Financial, August 2024. https://www.lpl.com/research/blog/a-deeper-dive-into-the-carry-trade.html
[6] "BOJ Won’t Raise Interest Rates If Markets Unstable, Uchida Says." Bloomberg, August 7, 2024. https://www.bloomberg.com/news/articles/2024-08-07/boj-won-t-raise-interest-rate-if-markets-unstable-uchida-says?sref=0NCA5RSF
[7] Lee, Tom. "VIX Falling from 66 to 27 Is a Positive Sign and Further Sign This Is a Growth Environment." FS Insight, August 7, 2024. https://fsinsight.com/macro-strategy/first-word/2024/08/07/vix-falling-from-66-to-27-is-a-positive-sign-and-further-sign-this-is-a-gro/
[8] Lee, Tom. "VIX Falling from 66 to 27 Is a Positive Sign and Further Sign This Is a Growth Environment." FS Insight, August 7, 2024. https://fsinsight.com/macro-strategy/first-word/2024/08/07/vix-falling-from-66-to-27-is-a-positive-sign-and-further-sign-this-is-a-gro/
[9] "FactSet Earnings Insight." FactSet, August 2024. https://www.factset.com/earningsinsight
[10] "FactSet Earnings Insight." FactSet, August 2024. https://www.factset.com/earningsinsight
[11] "GDPNow Forecast." Federal Reserve Bank of Atlanta, August 8, 2024. https://www.atlantafed.org/cqer/research/gdpnow