Market Minute – August 9, 2024

Are you familiar with the Butterfly Effect? It rests on the notion that the world is deeply interconnected, such that one small occurrence can influence a much larger complex system. The effect is named after the allegory for chaos theory: it evokes the idea that a small butterfly flapping its wings could, hypothetically, cause a typhoon. Now, I do not believe every time a butterfly flaps its wings, we have a natural disaster, however an occurrence such as the Japanese central bank raising its rates by a mere quarter percent sent shockwaves throughout the global markets, including the US. However, I would say the volatility in the markets was not as much caused by the Butterfly Effect, but more so by the Carry Trade Effect.  

A carry trade is an investment strategy that involves borrowing the currency of a territory where the interest rates are low and investing in a place where the interest rates are high. The Japanese yen has been a favorite currency to borrow in recent years due to historically low interest rates. Suddenly, without warning, the Japanese Central Bank raised interest rates. This is the first increase in 17 years, and the Federal Reserve indicated a possible half of one percent rate drop in the US in September. These two factors sent panic through the markets as investors had to sell higher priced assets (stocks) to repay trades. According to JPMorgan Chase, three-quarters of the global carry trade has now been removed.  

We expect the volatility and rotation of the market to continue through 2024. The unemployment rate climbed to 4.3% which happened to trigger something called the Sahm rule. The Sahm Rule triggers when the unemployment three-month moving average rises by half of one percent from its low of the past 12 months. When this occurs, it is said that we are in a recession or about to enter recession.  

Thursday the jobless claims report showed a decrease in initial jobless claims, sparking a rally in the market. The S&P regained most of its losses for the week but is still down 6.13% from its high in July. Unfortunately, I do not think Thursday’s report paints a true picture. Data shows that only one out of four, 25%, of unemployed individuals are applying for unemployment benefits. I still believe unemployment will reach 4.5% by the end of the year.  

As I mentioned last week, the economy is cooling, and the Federal reserve is in a tight spot. If they give into pressure and lower interest rates too early or too much, they risk igniting inflation. If they wait too long or do not lower enough, they risk prolonging recession. This puts them in a tough position. We continue to monitor the economy and where we are in the business cycle, simultaneously seeking opportunities that historically perform well. Proper diversification and stock selection is more important than ever in this environment.    

Have a wonderful weekend. 

Roger Fuller