Contributors
The Global Investment Strategy team
What’s happening?
Markets had a rocky start to the week. Monday’s session was met with a strong risk-off sentiment following last week’s jobs report, which showed a rise in U.S. unemployment. Tuesday brought some reprieve as global markets began to recoup at least some of Monday’s losses. Investors are still grappling with two major questions:
- Is the recent economic data weakness a shallow descent into a soft landing or a downward spiral toward recession?
- If it’s the latter, are rate cuts too little, too late?
Google keyword searches for “recession” hit their highest point in almost two years. On Monday, the CBOE Volatility Index (VIX), which gauges S&P 500 volatility, had its largest intra-day spike since 1990 and closed at its highest level since October 2020. We acknowledge that risks feel more elevated than they did even just a couple of weeks ago, but we’re not getting carried away: A soft landing remains our base case. While volatility could persist in the months ahead, we think it presents opportunity for cross-asset class investors.
How do we make sense of the moves?
Investor jitters surrounding the July U.S. labor market report, recent manufacturing data misses and a fear that the Fed is “behind the curve” were a sell-off spark for a market that was already characterized by high valuations and a concentration of performance leadership. We note three important dynamics as we consider the path ahead for markets:
- The rise in the unemployment rate probably overstates labor market weakness. The tick higher in the unemployment rate from 4.1% to 4.3% triggered what’s known as the Sahm Rule (it says that historically, a rise of 0.5% or more in the unemployment rate over a relatively short period of time signaled that the economy was in recession). It is a risk worth monitoring, but note that much of the rise was attributable to a surge in labor force participation and rise in temporary, not permanent, layoffs. To boot, other labor market data sets aren’t showing signs of a downward spiral, weekly unemployment claims data remains in-line with seasonal averages, and few companies are mentioning plans for layoffs on earnings calls. There are other tangible positives that persist in the economic backdrop, like the recently released Institute for Supply Management (ISM) Services Index data that surprised to the upside and points towards a continuation of the economic expansion.
- Market moves are being exacerbated by an unwind of global “carry trades.” Given how low rates in Japan have been relative to the rest of the world, it has offered opportunistic investors a compelling “carry trade” opportunity: Borrow (cheaply) in Japanese yen, then use the proceeds to invest in higher yielding assets elsewhere in the world. That opportunity has been narrowing, however, as the Bank of Japan pushes rates higher and the yen appreciates. Add the global market downturn, and “carry trade” unwinds get catalyzed as leveraged investors sell their global risk asset positions. These kinds of technical and positioning dynamics have added downward pressure on markets, but could wane in the weeks ahead as positioning normalizes.
- Geopolitical concerns add an additional sprinkle of anxiety. At the present, this seems to be a bit secondary from a market volatility standpoint but is important to acknowledge. There are concerns around a potential attack on Israel by Iran, which U.S. intelligence evidently believes to be imminent.
All considered, the Fed is likely paying attention to labor market data and the recent pickup in volatility. Markets are pricing towards a cut of 50 basis points at the September Federal Open Market Committee (FOMC) meeting; our own view calls for three cuts of 25 basis points through the end of the year. Either way, the “Fed put” is back in play – we don’t think conditions are deteriorating so rapidly that the Fed won’t be able to avoid recession with rate cuts. The soft landing still looks achievable.
What does this mean for investors?
For investors, it can feel uncomfortable when the risk pendulum swings rapidly from fears of sticky inflation to fears of an impending recession. But market moves like those witnessed at the start of August remind us that pullbacks are a feature – not a bug – of investing. Historically, the average year that ends with a gain for the S&P 500 comes with an 11% peak to trough decline. As of Monday’s close, the S&P 500 was about 8% below all-time highs. In other words, volatility is normal and shouldn’t derail a long-term financial strategy.
The recent market pullback may be an apt time to consider phasing into portfolios. Examine the potential benefits of extending duration as cash rates seem set to fall faster than expected. Most of all, assess your investments in the context of their role within a larger wealth plan.
Volatility is normal - don't let it derail your plans
S&P 500 intra-year declines and calendar year returns, %
This chart shows the S&P 500 calendar year price returns and maximum intra-year drawdowns from 1980 to August 2024.
- In 1980, the calendar year price return was 25.77% and the maximum intra-year drawdown was -17.07%.
- In 1981, the calendar year price return was -9.73% and the maximum intra-year drawdown was -18.35%.
- In 1982, the calendar year price return was 14.76% and the maximum intra-year drawdown was -16.56%.
- In 1983, the calendar year price return was 17.27% and the maximum intra-year drawdown was -6.91%.
- In 1984, the calendar year price return was 1.4% and the maximum intra-year drawdown was -12.68%.
- In 1985, the calendar year price return was 26.33% and the maximum intra-year drawdown was -7.66%.
- In 1986, the calendar year price return was 14.62% and the maximum intra-year drawdown was -9.42%.
- In 1987, the calendar year price return was 2.03% and the maximum intra-year drawdown was -33.51%.
- In 1988, the calendar year price return was 12.4% and the maximum intra-year drawdown was -7.63%.
- In 1989, the calendar year price return was 27.25% and the maximum intra-year drawdown was -7.56%.
- In 1990, the calendar year price return was -6.56% and the maximum intra-year drawdown was -19.92%.
- In 1991, the calendar year price return was 26.31% and the maximum intra-year drawdown was -5.6%.
- In 1992, the calendar year price return was 4.46% and the maximum intra-year drawdown was -6.24%.
- In 1993, the calendar year price return was 7.06% and the maximum intra-year drawdown was -4.99%.
- In 1994, the calendar year price return was -1.54% and the maximum intra-year drawdown was -8.94%.
- In 1995, the calendar year price return was 34.11% and the maximum intra-year drawdown was -2.53%.
- In 1996, the calendar year price return was 20.26% and the maximum intra-year drawdown was -7.64%.
- In 1997, the calendar year price return was 31.01% and the maximum intra-year drawdown was -10.8%.
- In 1998, the calendar year price return was 26.67% and the maximum intra-year drawdown was -19.34%.
- In 1999, the calendar year price return was 19.53% and the maximum intra-year drawdown was -12.08%.
- In 2000, the calendar year price return was -10.14% and the maximum intra-year drawdown was -17.2%.
- In 2001, the calendar year price return was -13.04% and the maximum intra-year drawdown was -29.7%.
- In 2002, the calendar year price return was -23.37% and the maximum intra-year drawdown was -33.75%.
- In 2003, the calendar year price return was 26.38% and the maximum intra-year drawdown was -14.05%.
- In 2004, the calendar year price return was 8.99% and the maximum intra-year drawdown was -8.16%.
- In 2005, the calendar year price return was 3% and the maximum intra-year drawdown was -7.17%.
- In 2006, the calendar year price return was 13.62% and the maximum intra-year drawdown was -7.7%.
- In 2007, the calendar year price return was 3.53% and the maximum intra-year drawdown was -10.09%.
- In 2008, the calendar year price return was -38.49% and the maximum intra-year drawdown was -48.01%.
- In 2009, the calendar year price return was 23.45% and the maximum intra-year drawdown was -27.62%.
- In 2010, the calendar year price return was 12.78% and the maximum intra-year drawdown was -15.99%.
- In 2011, the calendar year price return was 0% and the maximum intra-year drawdown was -19.39%.
- In 2012, the calendar year price return was 13.41% and the maximum intra-year drawdown was -9.94%.
- In 2013, the calendar year price return was 29.6% and the maximum intra-year drawdown was -5.76%.
- In 2014, the calendar year price return was 11.39% and the maximum intra-year drawdown was -7.4%.
- In 2015, the calendar year price return was -0.73% and the maximum intra-year drawdown was -12.35%.
- In 2016, the calendar year price return was 9.54% and the maximum intra-year drawdown was -9.3%.
- In 2017, the calendar year price return was 19.42% and the maximum intra-year drawdown was -2.8%.
- In 2018, the calendar year price return was -6.24% and the maximum intra-year drawdown was -19.78%.
- In 2019, the calendar year price return was 28.88% and the maximum intra-year drawdown was -6.84%.
- In 2020, the calendar year price return was 16.26% and the maximum intra-year drawdown was -33.93%.
- In 2021, the calendar year price return was 26.89% and the maximum intra-year drawdown was -5.21%.
- In 2022, the calendar year price return was -19.44% and the maximum intra-year drawdown was -25.43%.
- In 2023, the calendar year price return was 24.23% and the maximum intra-year drawdown was -10.28%.
- The last data point is as of August 2, 2024, where the year-to-date price return was 12% and the maximum year to date drawdown was -6%.
Source: FactSet, S&P. Returns are based on price index only. Intra-year drops refer to the largest market drops from a peak to a trough during the year. Returns shown are calendar year returns from 1980 to present year. Data as of August 2, 2024. Past performance is no guarantee of future results.
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