What’s New

We have been talking for quite some time now about the extent to which we believe that equity markets have been priced to perfection. Despite what we have viewed as complacency from investors, we have seen, and continue to see, several risks to both the economy and markets. These risks came center stage in early August, as complacency gave way to significant volatility.

Throughout the summer, data had been supportive of a resilient US economy. While the unemployment rate has been moving higher, much of this is due to growth in the labor supply rather than an increase in job losses (Federal Reserve Chairman Jerome Powell told us as much in his speech at Jackson Hole on August 23rd). Yet several data releases in early August spooked investors, triggering a sudden, serious worry about the state of the economy. This led to a semi-panicked discourse over whether or not the Fed had waited too long to cut and if we were witnessing a policy mistake in real time.

As a result, rates continued their strong move lower and fell precipitously through the first week of August. The 10-2 yield curve briefly uninverted, and equities followed yields lower.

As with anything in financial markets, nothing happens in a vacuum. The aggressive move in US sovereign rates followed a monetary policy meeting by the Bank of Japan in which they increased their policy rate to 0.25%, surprising markets. The resulting compression in US-Japanese bond spreads propelled the currency higher and sent the Nikkei to its worst day since 1987, falling by 12%, only to rebound nearly 10% the following day.

Yet as we moved through August, calm resumed—by month end, most major US indices were up very modestly. Subsequent US data releases assuaged concerns about any rapid deterioration in the US economy. At his Jackson Hole speech, delivering a dovish tone, Jerome Powell communicated it’s all but certain that the rate-cutting cycle will commence in September. The key questions now center on how quickly and against what sort of economic backdrop.

Our Perspective

What’s clear to us, though, is that very little has changed. Markets once again seem to be characterized by a degree of complacency that can quickly yield to volatility. This is set against a backdrop of softer US labor market, elevated valuations, what we view as overly aggressive expectations of cuts from the Federal Reserve, and elevated geopolitical tensions. Such an environment continues to necessitate balancing risk and reward in portfolios. We believe that our active approach to investment management will continue to allow us to uncover investment opportunities, while largely avoiding parts of the market where we see elevated risks moving forward.

We have been and continue to be concerned about the downside risks to the US economy. While we continue to see signs of softening, economic growth has remained incredibly resilient due in large part to the massive fiscal transfers undertaken in the months and years following the pandemic. We believe that we are now nearing a critical juncture; fiscal stimulus has mostly moved through the system and unemployment is rising. With the Federal Reserve on the precipice of its first rate cut in years, we are closely monitoring for signs that the much-needed normalization in the economy does not turn into something worse.

Unpacking August’s Market Frenzy

Read more of our thoughts on the significant volatility US equity markets saw in August, as well as our analysis of recent data releases and volatility going forward.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, we did see pain in industries including transport and manufacturing. The US consumer has remained strong. The lagged effect of monetary policy may start to be felt in other parts of the economy in the coming quarters, and we are keeping a close eye on the labor market.
Stock Market		The US stock market continues to trade near all-time highs. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansion. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		While growth has remained resilient and inflation remains above target, interest rates have come in off of their peak as the market has started pricing rate cuts from the Fed. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: After surprising to the upside to start the year, inflation has resumed its downward trajectory. However, we would caution that we are still well above target and upside risks remain.
		China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months.

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Source: Bloomberg, Wall Street Journal.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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Nikkei 225 Index is a price-weighted average index (the unit is Yen), designed to reflect the overall market based on a par value of ¥50 per share. That means, a ¥50 price change in any stock affects the average the same way, regardless of whether the stock is priced at ¥5 or ¥500 per share. The Nikkei 225 Index’s components are reviewed every year in September. Any changes, if required, are published in October and the Index is adapted accordingly.