August 2024 Market Lookback

A look at month-end performance data shows that August was another mostly positive month, but that misses the notable market stress in the first week of the month. The VIX surged to an intraday high surpassing 65 on August 5, as markets underwent a wave of selling and risk-off rotation. Japan was hit particularly hard, as a suspected unwind of the yen carry trade contributed to the upheaval. Treasury yields plummeted as investor demand for safe haven assets increased, with the 2y10y yield curve spread even briefly exiting inversion before falling back into it. As contagion concerns dissipated, however, stock prices bounced back and ended the month once again near all-time highs. And while Federal Reserve officials mostly brushed off the market turbulence, Chair Jerome Powell noted that “the time has come for policy to adjust.”

Macro

•   The unemployment rate rose to 4.3% in July, above all estimates and the fourth consecutive increase.

•   Powell signaled a shift in focus from inflation to focusing on the labor market, as well as the likely start of interest rate cuts at the September meeting.

•   While July CPI came in mostly in-line with consensus estimates at 0.2% m/m and 2.9% y/y, PPI came in cool at 0.1% m/m and 2.2% y/y.

•   After starting the month at ¥150 versus the U.S. dollar, the Japanese Yen appreciated to as much as ¥142 on August 5 amid carry trade-related volatility before finishing the month at ¥147.

•   Crude oil prices fell from $82 to $78 per barrel in July, while crack spreads remained near their lows of the year.

Equities

•   The VIX index rose to an intraday high of 65.7 on August 5, the highest level since March 2020.

•   Defensive sectors led the way in August, partially buoyed by a rotation toward less risky stocks.

•   Large-cap stocks outperformed small-caps by 3.9 percentage points.

•   Q2 2024 earnings are tracking toward 13.0% y/y growth and a surprise rate of 4.7%, with nearly all S&P 500 constituents having reported results.

•   Bottom-up 2024 EPS estimates for the S&P 500 fell from $244 in July to $242 in August, while top-down strategist estimates remained steady at $246.

Fixed Income

•   2 and 10-year Treasury yields began the month at 4.27% and 4.05%, respectively, plummeted to as low as 3.65% and 3.67% during the August 5 market stress, before both closed the month at 3.93%.

•   The 2y10y yield curve spread briefly exited inversion during the early-month upheaval, but ended the month inverted by less than 1bp.

•   High yield and investment grade credit spreads initially widened early in the month, but by the end of it were either back to where they began the month (IG) or below (HY).

Unwinding Popular Trades

To say that August started off with a bang would be an understatement. Almost immediately, investors began second-guessing the Fed’s mostly hawkish July 31 meeting, as the July jobs report showed fewer jobs added than expected, as well as an unemployment rate that rose from 4.1% to 4.3% (above all projections).

Markets fell that Friday, but it was the following Monday when markets were hit by severe volatility. Asian markets got clobbered, with Japan bearing the brunt of it: Japanese stocks fell 12% in a single day, while the yen saw significant volatility against other major currencies. The S&P 500 fell a more muted 3% despite an intraday high on the VIX of 65, the highest since March 2020.

Declining on disappointing data wasn’t surprising, but the suddenness of the market stress sure was. Unwinding of the Yen carry trade and short vol trade (in which investors bets against volatility such as short VIX futures) were the likely culprits, with the initial negative reaction to weak jobs data setting off a chain of selling.

Nearly a month later, asset prices were mostly back to where they were before the upheaval. It’s almost as if it never even happened. But are the underlying fragilities that led to this episode gone? Doesn’t seem like it.

A Midsummer’s Fed Dream

One of those main fragilities is the thing that kicked off this whole fiasco to begin with: employment. While a 4.3% unemployment rate in and of itself isn’t concerning, it’s already above where 16 of 19 FOMC Officials thought it would be at year-end. And because the labor market is typically seen as a lagging indicator, the full consequences of restrictive monetary policy might not yet have hit. You know: The fabled long and variable lags of monetary policy. That would mean even higher unemployment in the months to come.

Federal Reserve officials have noticed, though they’ve been more skeptical of its significance. In a speech at the Kansas City Fed’s annual economic symposium at Jackson Hole, Powell noted that instead of coming from increased layoffs, the increase in unemployment has come from more workers looking for work while hiring has slowed. In other words, it’s a cooler labor market but not a bad one.

Still, there was a clear pivot in the message, with Powell noting that the Fed does “not seek or welcome further cooling in labor market conditions.” It’s likely why the Fed has signaled rate cuts beginning in September, but whether that will prevent further slowing is another question. If it doesn’t, what happened in early August could turn out to have been a preview of things to come.

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Performance data quoted represents past performance. Past performance does not guarantee future results. Market returns will fluctuate, and current performance may be lower or higher than the standardized performance data quoted.

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