It was a hot, chaotic summer in the UK in more ways than one.
For investors, there was the unsettling sight of a market rout. In early August stocks in London as well as on Wall Street and in Tokyo plummeted, prompted by fears of a recession in the US, based on weaker than expected jobs data.
Investment bank Goldman Sachs warned that the chances of a US recession had almost doubled to 25% from 15%.
This whole business was though a tad bizarre. The US is in a good place with its economy growing at 2.8% in the second quarter. In addition, the S&P500 was, until that point, up 9% in the year-to-date.
There are two interpretations on what happened. One is an excessive fascination with the latest data, according to Jim Tierney, a portfolio manager at Alliance Bernstein.
“When it comes to the ties between fundamentals and day-today stock prices moves, I’m not sure they have ever been more disconnected than they are today,” he said.
The second points to a problem that emanates from group-think. “The market was so certain there would be a soft landing in the US, that there was complacency that any other outcome was even possible,” said Joe Davis, a global economist at Vanguard.
Too many investors had the same view of the world, he added, which has now resulted in a “repricing”.
A point shared by David Giroux, chief investment officer at T Rowe Price. “It was a reminder that when there is consensus thinking, the market can turn on its head,” he said.
For Wei Li, global chief investment strategist at Blackrock, the dramatic market falls demonstrated “how market narratives can swing based on single data points”.
It did result in huge market panic, albeit short lived. “The ferocity of the selling was reminiscent of the 2008 global financial crisis, but without the systemic risks,” said Bruce Kirk, Japan equity strategist at Goldman Sachs.
The whole business has though created investment opportunities. “We see a great opportunity to load up on more equity than we already have in our portfolio, mostly in the US because of the quality and transparency of earnings,” said Dan Scott, head of multi asset at Vontobel.
A fundamental view
The shift has now turned to a more fundamental picture, of which inflation is a key component.
In the UK, inflation rose by less than expected to 2.2% in July, slightly up from 2% since June, while service sector inflation stood at 5.2%. Although an interesting fact historically is that services inflation moves much faster on the way down than on the way up.
In the US, inflation dipped below 3% in July for the first time since 2021.
“While headline inflation ticked up as favourable base effects fade, services inflation – a crucial measure of domestically generated inflationary pressure – moderated,” said Aaron Hussein, global market strategist at JP Morgan Asset Management. “This coupled with moderating wage growth, suggests that inflation may finally be heading in the right direction.”
There remains a risk that cutting interest rates too quickly will fan the inflation flames.
“We therefore think it’s unlikely that the Bank of England will follow up its August cut with a cut in September. Absent any material shock to growth, this cutting cycle is likely to be gradual with a quarterly cadence most likely,” Hussein added.
Monica George Michail, associate economist at the National Institute of Economic and Social Research, is more cautious.
“Underlying inflationary dynamics continued to slow with core inflation at 3.3% and services inflation at 5.2%. Despite the lower figures, these remain elevated and may lead the Bank of England to exercise some caution with regards to further interest-rate cuts,” she says.
On the back of the market rout Richard Carter, head of fixed interest research at Quilter Cheviot, expressed concern about the market when it comes to judging inflation and the subsequent expected rate cuts.
“The market is potentially getting ahead of itself once again and expecting more cuts than will necessarily be delivered,” he said. “The economic picture is one of a weaker consumer and businesses coming under pressure, but they remain stable enough and as such rates will not come down quickly.”
Another concern is that the summer madness may not be over as we move into autumn. “We could see more volatility ahead,” Wei Li said.
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