You may have felt a slight sense of unease if you checked your portfolio on Monday. I’m with you because even paper losses hurt. Whether you’ve been investing for 12 months or 12 years, seeing your portfolio in the red feels the same. Investing involves ups and downs, and while we can’t control the market, we can help you navigate through it. Typically, our weekly email focuses on an in-depth analysis of global stocks, examining their fundamentals and potential performance. However, this week, it’s essential to reflect on recent events. We’ll break down what happened, explain the volatility, and offer practical tips to manage these common investment scenarios.
- Global stocks fell deep into the red on Monday following the unwinding of the Japanese ‘carry trade’ and weaker-than-expected US data.
- During a market sell-off, it’s crucial to stay calm, focus on your long-term financial goals, and avoid making impulsive decisions driven by fear.
- It’s important to zoom out and look at the bigger picture. The S&P 500 is still up more than 10% this year and up 100%, including dividends, over the last five years
View Watchlist
So, what happened?
You might have come across various explanations for Monday’s sell-off and still be wondering exactly what happened, so we’ll try to keep this nice and simple.
We need to go back to early last week when the Bank of Japan (BOJ) unexpectedly raised interest rates to 0.25%. That doesn’t seem overly significant in the grand scheme of things, but it is when you consider that Japan had negative interest rates from 2016 until March of this year. The recent hike surprised the market, catching people off guard, with the BOJ also signalling additional hikes this year. Years of easy monetary policy pressured the Japanese Yen, which fell over 30% against the US dollar in the last five years. This is significant, and we’ll get back to this.
Then, on Friday, bad news finally became bad news in the US. Unemployment rose more than expected to 4.3%, raising concerns of a looming recession. This sparked a broad sell-off in US stocks, with the Nasdaq the hardest hit, entering into correction territory in the time, down more than 10% from its peak. Essentially, investors believed the Federal Reserve had kept rates too high for too long.
Then if we shift back to Japan, the Yen continued to strengthen against the USD as Friday’s data signalled the Federal Reserve would cut interest rates sharper than expected. This is where we explain the ‘carry trade’. It is where investors borrow in low-yield currencies to invest in higher-yield ones. The Yen was popular for this given its weakness, but recent strength in the Yen and the hawkish stance from the Bank of Japan caused volatility and the unwinding of these trades.
In addition to these main points, investors are also dealing with heightened political tensions in the US, with the Presidential Election approaching, and rising geopolitical tensions globally. Over the weekend, we also learned that Warren Buffett sold nearly half of his Apple (APPL) stake alongside other holdings, bringing his cash pile to a whopping USD$277 billion.
The selling of equities to cash will have left many investors following in his footsteps on Monday. However, let’s add context to Buffett’s selling. Firstly, rebalancing: Apple surged to become his largest position, making his Apple stake overweight in his portfolio. Secondly, taxes: Buffett recently noted that Berkshire Hathaway (BRK.B) was paying just 21% tax on his Apple gains, down from as high as 35% and 52%. He believes taxes may rise in the future, so locking in a lower tax rate is smart business, not an indication he doesn’t see further gains in stocks.
Some recent good news may signal that the worst is behind us. Towards the end of this week, Bank of Japan Deputy Governor Shinichi Uchida sent a strong dovish signal, pledging to refrain from hiking interest rates when the markets are unstable.
Volatility and pullbacks are simply the price of entry into investing
It all made for a pretty manic Monday. However, that was just one trading day, and it’s not all bad. Long-term retail investors need to keep a level head during turbulent times. The key is not to panic, which can be easy after checking your portfolio.
Ultimately, the VIX, Wall Street’s “fear gauge”, hit a high of 65.73 and gained roughly 65% on Monday. Going back to 1990, that’s the second-highest one-day rally in the VIX, trailing only the 115.6% gain it saw on February 5, 2018, a day known as “Volmageddon.” The VIX had only topped 65.00 during COVID-19 and the financial crisis.
Remember, pullbacks are normal, and volatility is standard. Since 1974, the S&P 500 has averaged three pullbacks of 5% or more per year, while the average intra-year pullback is roughly 14%. Right now, the S&P 500 has seen a decline of around 8% since its recent highs. Things could get worse, but we’re still well within the range of normal right now.
Stay Focused
If you have a long-term investing plan, stick with it. A plan helps investors stick to the good ideas they came up with during calmer times. Those who consistently add to their long-term stock exposure tend to do well over time. As a result, longer-term investors should be pleased to see pullbacks, even when they get a bit scary. It can give the opportunity to buy high-quality assets at lower prices.
Selling investments in a panic can lock in losses. Historically, markets rebound, and those who stay invested often benefit from the recovery. Missing the best market days can significantly impact long-term returns. A JPMorgan study found that missing the ten best market days between 2004 and 2024 would halve your investment returns. Seven of those best days occurred within 15 days of the ten worst days.
We’re emphasising that timing the market is much harder than it seems, and getting it wrong can have significant consequences. A simple strategy like dollar-cost averaging can be highly effective. It rewards consistency over timing, allowing you to protect against the unpredictable nature of markets by spreading out your investments over time, typically in even increments.
The importance of diversification
This week’s volatility highlights the importance of diversification in an investment portfolio. By spreading investments across a variety of assets, diversification reduces the impact of any single asset’s poor performance. In times of market turbulence, not all sectors or individual stocks react the same way; some may even see gains, which can help offset losses in other areas. This strategy smooths out the volatility in a portfolio, providing a steadier return over time and leading to better risk-adjusted returns.
Let’s take an S&P500 ETF as an example, this can be SPY, VOO, or IVV. This type of ETF invests in the 500 largest publicly traded companies in the US, offering broad market exposure. The S&P500 includes a wide range of industries such as technology, healthcare, finance, and consumer goods, which means that the ETF is inherently diversified across multiple sectors. Within the S&P500, different sectors perform differently based on various economic conditions. For instance, during a pullback in the technology sector, other sectors like utilities or consumer staples may perform better, thereby cushioning the overall impact on the ETF.
Have the fundamentals really changed?
In our view, not really. One data point, such as last Friday’s job data, isn’t enough to derail the bull market. Up until this point, US data has been pretty positive, and let’s remember, the Federal Reserve has the flexibility to cut rates from here, which is a catalyst that we see as broadly positive. Strong economic growth also supports optimism. US GDP grew by 2.8% in the second quarter, continuing a trend of over 2% growth in seven of the last eight quarters. US Inflation has also now reached its lowest level since 2021.
Solid earnings growth is another reason for investors to be optimistic. With over 80% of the S&P 500 reporting, earnings are up around 11% annually, the fastest since late 2021, and revenues have grown for 15 straight quarters. We weren’t expecting to see double-digit earnings growth until next quarter, so the fact we’re beating expectations is positive.
On the other hand, questions have arisen about tech companies spending heavily on AI. Recent weeks have shown that Microsoft (MSFT), Alphabet (GOOG), and Meta (META) are increasing spending. Mark Zuckerberg announced that Meta is spending USD$37 billion, more than initially planned on AI and may spend more. However, these investments take time to materialise, and big tech names have no time to waste asserting their dominance in AI. Investors will need patience and should see current investments as well placed.
This is a great time to review your portfolio. Make sure you know what you own, and why you own it.
The bottom line? Seeing your portfolio in the red is never easy, but we’re here to help you understand that it’s okay and to provide you with the tools for successful investing. No one has a crystal ball to predict the future, and another pullback is likely at some point, though we can’t say when. But what’s important is that markets have always gone higher throughout history, and we don’t believe that it’s done yet. Zoom out and look at the bigger picture—this is merely a blip.
Follow Josh Gilbert on eToro and LinkedIn for more insights.
View Portfolio
eToro Service ARSN 637 489 466 promoted by eToro AUS Capital Limited ACN 612 791 803 AFSL 491139. Capital at risk. See PDS and TMD. This communication is general information and education purposes only and should not be taken as financial product advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial product. It has been prepared without taking your objectives, financial situation or needs into account. Any references to past performance and future indications are not, and should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication