Join Fund Library now and get free access to personalized features to help you manage your investments.
For many, summer months are a time to slow down and reset for the coming colder weather. Yet for investors, it’s often a time to be on edge, as August has gained the reputation as the month that volatility begins to increase, and strange things occur. If that is what you were expecting heading into the month, you weren’t disappointed this year. As the calendar flipped from July to August, it signalled a marked change in financial markets even as most indexes remain near all-time highs.
While many Canadians were enjoying a long weekend, the first Monday of August saw one of the largest spikes in volatility ever. The VIX index, which measures volatility in the options market and is often referred to as the “fear index,” surged from a reading of 15 to 65. This was the largest one-day change in history and touched a level seen only twic this century – during the early days of Covid and the Global Financial Crisis of 2008.
Moves like this are not normal, and everyone was left trying to explain what caused them. The blame for the sudden surge of volatility and the rapid near 10% fall in equity markets was placed on developments in Japan, but there were plenty of other reasons as well.
Japan has had negative interest rates for years to encourage investment and, with it, has seen a weakening of the yen. As a result, many global hedge funds put on what is called the “yen carry trade,” which basically is a pair trade by which you borrow in Japan to fund buying what you want to be long. The last week of July saw the Bank of Japan do its first rate hike in years, returning to zero. This caused the yen to rally and the carry trade to be less attractive. This caused some forced selling of positions, and in a low volume August Monday, when many were out of the office, there were no buyers to offset this selling. The result was the quick drop we saw.
Buyers showed up to take advantage of this dip, and markets began to rally. Still, events in Japan aren’t the full story, as other risks are out there and remain. During the last week of July, we also had the U.S. Federal Reserve’s Federal Open Market Committee (FOMC) meeting, which many had seen as disappointing. Most global central banks had begun cutting rate, and there was a hope that the FOMC would follow in July. The fact that they didn’t left many wanting. Markets have a tendency to try to force the banks into action, and to some degree, the violent move in August may have worked. Now, everyone is fully on board with U.S. rate cuts beginning this month.
The other reason some are citing for the selling was the rapid shift in the U.S. election odds away from former President Trump and towards VP Harris. Markets had gotten very comfortable that former President Trump would return to office. He was known to measure his approval on higher equity markets and would be very business-friendly. With these odds falling and more questions being asked about the Democrats' positioning, this increased uncertainty. Markets hate uncertainty.
So, while the unwinding of the yen carry trade was the spark that lit the selling fire, there were many reasons for investors to become nervous. While most will look favourably at the end results of a flat to slightly positive month, the problem remains that these other risks haven’t gone away.
We have just finished reporting earnings for the first half of the year. While most results were ahead of expectations overall, several concerning points are arising. On both sides of the border, the consumer is starting to struggle with higher costs. Retailers and banks both cited these concerns, leading more to question whether market expectations of a recession being avoided may be wishful thinking. This will increase the odds of future rate cuts.
On the positive side, we have seen a few developments. With the market fully expecting the U.S. to join the rate-cutting party, we are finally seeing weakness in the U.S. dollar. A lower U.S. dollar is good for real assets and commodities. The fact that gold has been acting so well in the face of a stronger dollar has been notable, but now that the U.S. dollar is falling, we could begin to see an extended move higher for all commodities.
The lower U.S. dollar and a decline in interest rates have added more momentum to the sector rotation we have been looking for. For too long, the market was held up by only a handful of names, mainly in the technology sector. Through the summer, that leadership has begun to fade as many question whether the AI hype got ahead of itself. This is a positive in the long term. Narrow markets are unhealthy, and having other sectors act better is a great development. For the balance of the year, look for a continuation of this trend.
While August started with one of the fastest selloffs many have seen, the rest of the month was calmer and constructive, finishing with a positive return. While it’s nice to celebrate after near-death experiences, it's much too soon to think the volatility we saw a few weeks ago was all we were due to experience. September and October remain the toughest months historically and will be tricky.
We will see the beginning of rate cuts in the U.S. and a continuation of cuts in Canada. Both central banks are trying to thread the needle of slowing inflation while not crashing the economy. In addition to this, continued geopolitical risk and the U.S. election, no one should be surprised if the spike in volatility we saw at the start of August isn’t repeated at some point in the next few months.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2024 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Macro commentaries” page of the Purpose Investments’ website and has been updated. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.
Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.
Image: iStock.com/delmonte1977
Join Fund Library now and get free access to personalized features to help you manage your investments.
Fund Library
