Market Comment - August

Investors have a well-known history of being either overenthusiastic or overly fearful. By comparing the volatility of earnings with the volatility of equities, the obvious observation is, that stocks are much more volatile than their earnings. The source of course is, the exceeding optimism, or pessimism the crowd holds. The source of volatility can vary, but in the end, it leads to extreme greed or fear among investors and the result is irrational behaviour. The S&P500-Index managed to drop 7.01 % during the first three trading days of the month, only to rally back during the remainder of the month, to finish August up 2.38%. The expectations for a rollercoaster market have been truly met. Equity markets are the place where all kinds of investors meet, and it looks like that “trend-followers” have been the main source for the artistic gymnastic of equity indices during the past four weeks. The infamous “carry-trades” coupled with short positions in volatility are said to be the main culprits of the spectacular market moves. While volatility has calmed down until the end of the month, the framework of the S&P500 has changed. The technology sector continues to underperform, while defensive sectors started to outperform. Especially the consumer staples sector staged a strong comeback on a relative basis, something investors don’t like to see. In addition, Crude Oil remains under heavy selling pressure, which removed once again the appetite to add exposure in the commodity sector. While a FED rate cut is now fully backed in the cake, investors start to ask themselves, if the FED is acting too late, and a recession is imminent, or if we just witness some cracks in the economy, that can be easily fixed by lowering interest rates over the next months. China remains a particularly negative factor for the global economy. The country continues to face deflationary forces emerging from the real estate sector. This translates into a weak Yuan, a substantial factor for the disinflationary trend we are witnessing today. A restrictive policy emerging from the Bank of Japan (BOJ) could additionally reduce the global liquidity level. Consequently, we are seeing fears emerging that the disinflationary trend will move into outright deflation. Subsequently, as ironic it may sound, for the S&P500 to find any comfort, inflation expectations will need to turn back up. Deflation would be an absolute worst-case scenario for a global economy, that is built on debt. Too weak inflation expectations will move markets to tilt towards recessionary pricing and this would mean, much lower prices for risky assets, or even the end of the secular bull market. A silver lining against the deflation trade is Gold. The yellow metal has a solid reputation to be a harbinger of inflation. In addition, we have an interesting correlation between the US 2-Year Yield Curve and commodities. The Yield Curve usually rises ahead of commodities and once the trend becomes strong, commodities follow. Maybe we will get a deflation scare in the next couple of weeks, which turns out to be false, because scary markets lead to fear and as a result, to irrational behaviour. The next FED meeting in September could well be, in the short run, a deception for the markets whatever the central bank decides. A 50 bps. rate cut would mean that the FED is in panic mode. A 25 bps. rate cut could mean, it will be not enough. Of course, we will get additional economic data in the coming weeks, that will keep investors busy. One thing is sure, the next couple of weeks will be among the most difficult of the year.