I heard a great line this week - "There are decades where nothing happens and there are weeks where decades happen". This feels like one of those weeks where decades happen.
To put it simply, there are 3 main events that having been impacting the volatility this week.
- The market began to sink last week as it became clear that the data was softening and the Fed was once again behind the curve in lowering interest rates. Initial jobless claims and other disappointing data sent the S&P 500 down 1.4% on Thursday. We got more weak employment data on Friday, and the S&P dropped 1.8%, its worst two-day decline since the Silicon Valley Bank collapse in March 2023.
- Blowing air on the flame, over the weekend we learned that Buffett dumped half of his Apple exposure. Apple is still 30% of Berkshire’s equity portfolio at the end of the second quarter, making it still Buffet's largest single position - by far. But context aside, Apple was likely to fall on this report, dragging down mega-cap tech with it.
- The spark that lit the fuse happened last week in Japan when their central bank hiked interest rates. On Sunday night came the explosion. In the words of the Wall Street Journal: "For years, global investors snapped up riskier assets, such as U.S. stocks, and funded those trades with the Japanese yen, thanks to ultralow interest rates in Japan. Until recently, many hedge funds and asset managers expected that rates would remain low and the yen would remain weak. Known as the carry trade, this strategy was yielding money for investors. Then the Bank of Japan raised rates, causing the yen to appreciate about 7.6% against the U.S. dollar over the past week." This caused a series of margin calls, liquidations of large positions, and selling that cascaded through the global markets.
As a result, the VIX, or the indicator that is used to measure expected volatility in the markets, is at the 3rd highest rate since it's inception in 1970, with the other two times being the Great Financial Crisis and COVID 19.
The question then becomes - What are you supposed to do as investors? As you've heard us say before, and what you will have to hear from us again, is that there is always a reason to sell.
What's important is how we react when these inevitable bouts of volatility come around. Do we look to use them as a buying opportunity? Should we sell out and limit our downside and upside? I always think of the graphic below when these thoughts begin to creep in.
Over a 15 year period from 2005 to 2020, there were 3,780 trading days in the stock market. If you stayed fully invested in the S&P 500, you'd earn a 9.88% rate of return. If you missed the 10 best days in the market over that time frame, your return is less than half of that amount on an annual basis. The point being, we can't afford to have anyone missing those up days.
Some things we are observing:
- Interest rates have come down this week in response to the volatility for a couple of reasons - Investors poured money into bonds as a flight to safety and there is a higher expectation of The Fed cutting rates more aggressively before the end of the year. Some home buyers were able to lock in mortgage rates in the high 5% range yesterday. This is a great development for those of us that remember the pain of 2022. That year was so horrific for investors because the risk-off portion of their portfolio provided no stability. Bonds got hit just as hard as stocks did that year. This time around, bonds are providing diversification. Bonds are up 2% over the last four sessions.
- Allow me to offer a positive outlook on what looks to be a very ugly day. This is an unwind: margin calls, leverage, selling everything, etc. We would much rather see this type of selloff than one that’s caused by earnings tanking and a re-rating in stock market multiples. As I write this the markets are rallying back - for now.
We obviously understand that seeing your accounts go down so sharply is unsettling. It doesn't make our job particularly fun either. There's a saying in investing that stocks take the escalator up and the elevator down. The past week is a prime example of that. From October 27th of last year to July 16th of this year, the S&P 500 was up 37.64% - an all time high. Since then, the S&P is down 7.22% - to keep things in perspective.
We don’t know when the selling stops or what this means in the long term, but I do know that this too shall pass. There are always reasons to sell.
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Source for "Reasons to sell" chart - Ritholtz Wealth Management Data via YCharts