08/05/2024
“That Wasn’t So Bad”
For those new to investing, today is a reminder that up isn’t the only direction. While many of you were sleeping, I was trying to figure out why the Japanese stock market was careening off a cliff. Around midnight, the Nikkei 225 index was down about 7%. At the same time the Dow Jones Industrial futures were trading down less than 1%. The tech heavy Nasdaq futures were sliding down about 3%. Although I have been anticipating some weakness in the markets, these moves were a little aggressive. By the time I woke up around 6am eastern time, the Nasdaq futures were headed down over 6%. This kind of outsized move typically follows some kind of event. The last time markets were this volatile was during the spring of 2020. At that time we had a global pandemic, and airplanes were literally being grounded. I scoured my resources to see what was behind this volatility, and nothing seemed afoot.
I spoke to some clients on Friday about my concerns that market conditions could soon become volatile. Many are focused on things like the US presidential election, or the price of gas at the pump. I have been examining several data points, and this is one of the most complex scenarios I’ve ever seen. It’s not just one thing that is leading to these extreme moves in the market. It is a perfect storm. As I write this, Hurricane Debby is pummeling the east coast, and it has nothing to do with why your investment accounts just fell out of bed.
What’s happening in Japan is a few decades in the making. The stock market there is at the same levels it reached back in 1988. Stocks can be brutal and last that way for a long time. This recent move off the coast of Asia may just be the beginning for the country that makes Toyotas. You can overlay a chart atop the Japanese stock market, and their currency relative to the US dollar, and it almost looks identical. The Dollar/Yen trade peaked in July just a tad above $160. It cratered over the past few weeks. To simplify this activity, when the USD/Yen ratio declines, the amount of dollars necessary to buy a Toyota increases. This negatively impacts Japanese exports. Considering that Americans are the wealthiest consumers on the planet, when they aren’t buying as much, the whole world feels it.
Japan recently raised their benchmark interest rate. This is the opposite of what many other central banks are doing right now. Americans are eagerly waiting for the Fed to lower interests rates. Don’t worry, it will come soon enough. These currency and interest rate dynamics can seem like a chicken versus egg situation. Do we lower interest rates to keep the economy from slowing, or do we lower interest rates because the economy is already slowing? Both can be true simultaneously.
Enough about currency markets and interest rates. I want you to pay attention to these two key data points; the US unemployment data, and the Vix index. We all know what unemployment means. Some may have never heard of the Vix index. This is a gauge to measure the amount of price volatility in the stock market. Volatility occurs when buyers and sellers have widely different perceptions of what an asset is worth. Imagine you list your house on the market for sale at $500,000. You’re excited when your agent tells you that there’s an offer on the table. You slide out of your chair when you hear that the buyer is willing to offer $300,000. You reject their offer as you assess the value of your home. Meanwhile, your house is not selling. Imagine that this price dislocation happens with every house in your neighborhood. Once the neighbor down the street sells at this depressed price, as the saying goes, “there goes the neighborhood.”
When volatility is high, prices tend to go lower. Panic ensues and markets can crash. The Vix spiked today above 60 before I even had my cup of coffee. To quantify this move, it has barely broken above 20 for over a year. These levels of volatility is what we experienced when we were uncertain of the consequences related to shutting down the global economy during the pandemic. I think this ties perfectly into the unemployment rate. There are trillions of dollars invested in 401(k) retirement plans. Americans contribute to these plans like clock work every two weeks when they get paid. Most of this money is allocated to passive investment mutual funds which simply track the market. That means the American worker is the natural buyer of the US stock market. When unemployment rises, there are less people to make those 401(k) contributions every two weeks. Just think about the subsequent action when people lose their jobs. Not only are they no longer investing in the stock market, they turn into sellers of the stock market when they liquidate their 401(k) plans just to pay the mortgage.
The recent tick up of unemployment may have been enough to spook the markets, coupled with a barrage of other data points that lead me to believe that things could be more volatile in the near future. This may be complicated for many investors. My phone rang a few times today with the ominous question; “what do we do now?” It’s easy to talk about what should have been done. While a large part of the Lyles Wealth Management portfolio has been allocated to cash and bonds, it won’t be enough to avoid the ensuing volatility. Whatever you do, don’t panic. This storm is not over. There were too many smiling faces on CNBC today. You’ll know when to expect a moderation of volatility when the news anchor spits out their latte live on air amazed at the red flashing on the screen. If you are invested in the stock market, it’s not too late to ensure that what you own are companies with solid balance sheets, positive cash flow, and P/E valuations no more than 20% above their five year average.
The market sell off today was rather orderly. There wasn’t any private equity funds that were forced to liquidate. No major bank announced struggles meeting reserve requirements. I didn’t see any municipalities file for bankruptcy. This is not 2008 nor 2020. That doesn’t mean that things can’t get worse. While I do have a favorable outlook on the markets over the next year, we could see lower prices in the interim. Today wasn’t as bad as you might think on a relative basis. Let’s see how the next few weeks go. If you’re nearing retirement, just remember that this is still a multi decade cycle for many. It can be easy to want to stuff your mattress with $50 bills. Before you do anything like that, make sure your homeowners insurance covers that. If you’re wondering how sky rocketing insurance premiums play into this equation, just know that I’m tracking that datapoint as well. Stay the course and turn off the tv. If you plan well, things will be fine.
* The views and opinions expressed here are not to be viewed as direct investment advice. Investments involve risk, and may not be suitable for all people. Consult your own financial professional before making investment decisions. Past performance is not indicative of future results.
Written by: Adrian Lyles
