Stock market falls and volatility increases
The first days of August 2024 have left us with a panorama of some uncertainty in the financial markets, marked by significant falls and an increase in volatility:
-On August 5, the Japanese stock market suffered an exceptional fall of 12.4%. The fall in the Nikkei 225 (Japanese stock index), as shown in the following chart, is only comparable to three other fateful dates in the last thirty years.
-In addition, the US stock market fell by 3% and
– The VIX (CBOE volatility index), known as the “fear index”, rose by 50%, reaching its third highest value in history.
What is behind these movements?
As usual, experts have tried to identify the causes of these events, pointing out different factors such as:
Simplified example of a carry trade, assuming that the currency is stable and that the investment is in monetary assets. But in reality the currency is not stable (the Yen has devalued, adding profitability) and the investment is also in equities (which would explain the fall in the stock markets).
- The “carry trade” (which we can translate as “interest rate differential exploitation strategy”): This investment strategy involves borrowing in a currency with low interest rates (in this case, the Japanese yen) to invest in assets denominated in a currency with higher yields (such as the US dollar). The recent interest rate hike by the Bank of Japan (BoJ) is believed to have triggered a massive sell-off of these positions, particularly affecting technology stocks in the US.
- US unemployment rises: The unemployment rate rose to 4.3% (from 4.1%) previously, still low by historical standards but enough to raise concerns about a possible recession.
We will never really know what the main reason is. The markets may have simply fallen because they were supposed to. Corrections of this type are common and occur on average once a year.
There is also the feeling that during the summer, these situations tend to occur more frequently (due to a drop in volume).
The reason may be even simpler: markets have risen too quickly in recent months with almost no pullbacks, and this is not normal either.
Amid these concerns, the positive effect of a possible rate cut by the Federal Reserve this coming September, now expected to be 0.5%, seems to have been overshadowed. In fact, some criticise the Fed for having already taken too long to react.
At the time of writing this post, there have already been some rebounds: the Japanese market recovered strongly the next day and the other markets have also rebounded, recovering some of their losses. But it cannot be ruled out that volatility will continue in the markets for some time, market corrections and bear markets are part of their nature. Although it is also true that markets go up more and more for longer.
The biggest concern at present is how the BoJ will balance its monetary policy in a challenging economic environment. There is considerable fear that a premature tightening of its monetary policy could jeopardize the economic recovery in Japan. Moreover, in recent years, Japan has played a vital role as a source of global liquidity, countering the restrictive monetary policies pursued in other developed economies. In other words, a change in BoJ monetary policy may have a global impact.
Recommendation in this situation: stick to your plan(s).
In these situations our recommendations are very constant:
1-Don’t panic
If you have designed your investment plans wisely and aligned them with your goals and time horizons, these fluctuations should be mere anecdotal episodes for you. Ignore them and stick to your plans.
If this is not the case, consider point 3.
2-Systematize your investment with periodic contributions
The best way to invest is to systematize your investment plan. One of the best ways to invest so as not to be carried away by our weak financial psychology is to automate the entire investment process.
In inbestMe you have several ways to schedule periodic contributions.
Periodic contributions are a very good system to overcome our biases and it is even highly recommended to overcome corrections or even bear markets.
3-Re-evaluate your objective distribution and your risk profiles
Market corrections are not pleasant, we know this because we have experienced them too.
However, they are an excellent opportunity to assess whether your risk tolerance is aligned with reality. It’s easy to invest aggressively when everything is going up, but actually experiencing the downside of the market is another matter. If recent declines have made you hesitate, it might be necessary to adjust your plans and profiles.
Falling situations can help us identify errors in the evaluation of our horizons or objectives. They can also make us realize that we are taking risks that we really cannot bear. If this is the case, we advise you to re-evaluate your distribution of objectives and your investment plans.
Still, don’t rush into things: once the volatility has passed, consider whether it’s really worth making changes or whether it’s better to stay the same.
At inbestMe, we are firm believers in segmenting our goals into different investment accounts, as this allows us to more effectively manage inevitable market volatility. If you haven’t done so, consider segmenting your goals: it’s much more important than it seems.
4-Follow your plan(s)
We know from experience that it is not easy to remain calm when financial markets are falling, but history has shown us that corrections are common and will happen again.
And that same story tells us that investors who stick to their investment plans are the ones who really win over time.
If you have already done all of the above, the best we can recommend is that you do nothing and stay on track with your plans.
