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Will Brown
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August 2024: Summer Update

Summer Update

As we reach the midpoint of summer, the only thing rising faster than the thermometer has been the VIX, a widely followed measure of market volatility. Since school is still out, we will keep this brief and focus on the five things clients are asking us:

1. Why are stocks lower?
   1. Two main reasons.
      1. One, the U.S. economic data last week showed signs of weakness, especially on the labor front. The rise in unemployment triggered the Sahm rule, which has historically been a reliable recession indicator. However, the economist who created the rule, Julia Sahm, wrote in a Bloomberg article that this may not be the case this time.
      2. Two, and probably more importantly, the Bank of Japan modestly increased interest rates from zero. Without getting too technical, Japan’s currency, the yen, had fallen to multi-decade lows versus the dollar. Hedge funds had borrowed massive amounts in yen, given the low rates, as part of the so-called carry trade, and were surprised by the rate increase.

2. Why is volatility so high?
   1. Globally, it’s because markets have been incredibly volatile. For example, Japan’s market fell by 25% in less than a month (including over 12% this Monday), before bouncing 10% the next day.
   2. Domestically, the VIX index, a widely used barometer for market fear, hit 65 on Monday. We have seen this level on the VIX on only two other occasions: the Covid selloff in February 2020 and the Global Financial Crisis. The level of fear was completely incongruent with an S&P 500 Index down only around 10% from its recent all-time high.

3. Is this normal?
   1. On the volatility side, no. The red dot shows what an extreme outlier Monday was.
   2. However, a 10% decline is perfectly normal. Stocks experience a 10% decline, on average, about once every 12 months. And, since 1980, the average annual drawdown from the high for the S&P 500 is about 14%. Part of investing in stocks is the potential for declines, and what we have seen so far is in line, if not a little milder, than normal decline.

1. Why does this feel worse?
   1. Probably because U.S. stocks had been so calm for so long. The S&P 500 went 356 trading days without a 2% decline before that streak ended on July 24. This was the longest stretch without a major daily decline since 2007.
   2. Also, for the first time in recent memory, the so-called Magnificent Seven stocks are lagging the Index. (These numbers were as of the close on August 7^th):

Source: FactSet

5. What’s next?
   1. One of the more insightful traders we follow describes VIX as a temperature gauge versus a fear gauge. When people have a dangerously high fever, they normally don’t get better overnight; markets are usually the same.
   2. This Bloomberg article compares the events of the last week to a tectonic shift, where we won’t know the full effect for some time. The subsequent tsunamis (if any) may not appear for weeks.
      1. Longview Economics looked at 15 S&P 500 selloffs since 1978 when an initial wave of selling brought the index down by at least 10% (which happened Monday intraday).
         1. In 13 of 15 examples, retest of low occurred in a subsequent wave of selling (i.e., after relief rally).
         2. The two exceptions were April 2012 and October 1997.
      2. Coincidentally, we were vacationing in a tsunami hazard zone last week. The advice on the sign: go to high ground or inland. Our advice from a market perspective: go to high quality and stay diversified. Talk with your financial advisor and remain focused on the long-term. Once volatility arrives, it often doesn’t recede quickly, and we continue to see large moves in both stocks and bonds.

Source: Eagleston Family Archives