Olivier de Berranger, Managing Director and Co-CIO, and Enguerrand Artaz, Manager at La Financière de l'Echiquier, share their thoughts on the recent summer turbulence, which marked a decisive turning point in investor psychology. Are these fluctuations the sign of a simple return to normal, or do they herald a more profound change? Dive into their analysis of current dynamics and asset allocation opportunities in a rapidly changing economic context.
Summer stress episodes are one of those unfortunate market habits that investors could do without. The one that occurred in the first few days of August was soon forgotten. Yet the triggers were as numerous as they were serious: a very negative surprise on unemployment in the United States, a massive unwinding of speculative short positions on the yen after an unexpected rate hike by the Bank of Japan, rumors of a delay in delivery of Nvidia's new chip and renewed tensions in the Middle East.
.But there it is. A few weeks after this panic attack, most stock market indices have fully recovered from the drop, including the Nikkei, the flagship index of the Tokyo Stock Exchange, which had collapsed by almost 20% in just a few days. In the United States, the S&P 500 almost regained its mid-July highs and the Dow Jones broke new all-time records.
A change in market psychology
However, to dismiss this correction as an inconsequential event would be a little hasty. In reality, it represented a tipping point in market psychology. For more than 2 years, between inflation and rate hikes, the markets had followed the "bad news is good news" logic. In other words, poorly oriented macroeconomic data, or below expectations, were seen as good news, since they suggested less economic dynamism likely to reduce inflationary pressures, and thereby allow central banks to halt their monetary tightening before starting to cut rates.
.Risk reassessment
The situation has changed radically. In the developed countries - with the exception of Japan - rate cuts have begun, in the eurozone, Canada, the UK..., or are on target, as in the USA, against a backdrop of disinflation well advanced. So, as bad economic data is no longer necessary for central banks to ease policy, it is back to what it fundamentally is: bad news. The particularly negative reaction in equities triggered by the surprise rise in US unemployment materialized this change of mindset: the markets have returned to their "bad news is bad news" logic.
Somewhat healthy in the long term, this return to normalcy was accompanied by another flip-flop. In recent years, the anti-correlation between stocks and bonds had been beaten to a pulp. In particular, in 2022, as investors worried about rising interest rates - and hence falling bond prices - equities had fallen significantly. Conversely, the sharp easing in interest rates at the end of 2023 led to a powerful rebound in risky asset markets, with equities and bonds appreciating in tandem. Last August's correction, on the other hand, saw a return to the opposite movements to which the two asset classes have become accustomed. Worried about the sudden deterioration in US employment and the return of the risk of recession, equity markets fell sharply. Seeing in it the possibility of an accelerated rate cut by the Federal Reserve, bond markets appreciated significantly.
New room for manoeuvre for investors
This further return to normalcy has one virtue: it gives investors new room for manoeuvre in terms of allocation, as bond assets can once again play their role as a safety cushion. At a time when doubts about the solidity of the US job market are growing, this prospect is reassuring. In contrast to the annus horribilis of 2022, investors now have well-identified safe havens - overweighting bonds, switching from cyclicals to defensives and visible growth stocks - should the markets' central scenario of a soft landing for inflation and growth be undermined. While we wait for a third return to normal: that of the valuation of small and mid caps, still historically low compared to that of large caps.
The opinions expressed in this document correspond to the convictions of the authors. LFDE cannot be held responsible for them. Stocks and sectors are cited by way of example. Their presence in the portfolio is not guaranteed. Drafting completed on 04.09.2024.
This post was translated from the original French.