The stock market in 2023 was eerily calm in the face of many discouraging news: geopolitical turmoil, stubbornly high interest rates and a possibly contentious presidential election. The low volatility was explained by an economy that, against all odds, continued to perform above par.
And then the calm stopped. Today, we woke up to a crashing Japanese stock market, followed by better but still down European and US markets. The VIX index had one of the biggest jumps in its history indicating that investors were panicking and buying insurance at any price. Ultimately, the US indexes closed the day down between 2.5% and 3.5% give and take a few points. A bad day but not a crash.
An “autopsy” of today’s action reveals some interesting elements. While it is very probable that the US economy is finally slowing down (and we have been in that camp since the end of last year – admittedly way too early), we do not believe we are about to witness a ferocious recession like the ones in 2008 or 2020. A slowdown of the economy is needed to eliminate the last remaining inflationary pressures and to weed out inefficiency in capital allocation. After all, how much capital can we throw at NVIDIA?
The surprising volatility of today’s action has probably been exacerbated by the end of the so called “carry trade.” This is reflected by the much more significant correction in Japan (-12%) relative to the rest of mature markets. The carry trade consists of funding speculative and high yielding bets by shorting the Yen. This is because the rates on the Yen are so much lower than for the USD or EUR. However, the convergence of a renewed possibility that the Fed will reduce our rates faster than expected and the fact that the Bank of Japan actually raised rates recently, made the Yen rise and forced the closure of leveraged bets financed by the Japanese currency.
Mini crashes like the one experienced today are usually not a good reason to either sell indiscriminately nor to make changes to long term allocations. The next twelve months will probably look different than the last twelve and we expect value companies to outperform growth and tech. This is a theme that we have highlighted since last year. We also feel that bonds are once again good complements in allocations.
On a closing note, we quote Jon Sindreu of the Wall Street Journal who reminds us that 87% of the time when investors bought the S&P 500 on days when the VIX closed at 30 or above (today we closed at 38.57) ended up with a positive result twelve months later.