Weak data and tech worries drive equity selloff

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What happened?

US equities fell and bonds rallied on Tuesday as the ISM manufacturing index signaled ongoing weakness in the US industrial sector, while NVIDIA and other megacap stocks came under pressure, contributing to the market’s slide.

The S&P 500 fell 2.1%, its steepest decline since 5 August, as markets resumed activity following the Labor Day break. The tech-heavy Nasdaq Composite dropped 3.3%, with megacap tech stocks losing ground across the board. NVIDIA led the decline, falling 9.5%. The AI chipmaker’s shares have been volatile since the company reported earnings last week. On Tuesday, Bloomberg reported that the US Justice Department sent subpoenas to NVIDIA and other companies in an antitrust investigation.

The ISM manufacturing report added to investor concerns about the health of the US economy. The headline index edged up slightly to 47.2 in August from July’s eight-month low of 46.8, but it remained in contractionary territory and missed consensus estimates. The new orders component dropped sharply to 44.6 from 47.4 in the previous month, marking its lowest reading since May 2023.

Bonds rallied amid the risk-off sentiment, with the yield on 10-year Treasuries dropping by 7 basis points. Futures markets are now priced for the Federal Reserve to cut policy rates by roughly 100 basis points in the remainder of this year. The risk-off move carried through to Asia on Wednesday, with Japan's Nikkei 225 falling 4.2%. S&P 500 futures are down 0.4% at the time of writing.

What do we expect?
We expect stocks to trade higher over the coming 6-12 months but would not rule out renewed volatility in stocks in the near term.

September has historically been a poor month for returns, suggesting some seasonality may be playing a role in negative sentiment. The S&P 500 has declined in September in each of the last four years and seven of the last 10. This historical context may help explain why Tuesday's move could be signaling a broader risk-off sentiment as investors brace for potential volatility.

Additionally, uncertainty about the economic growth outlook may affect expectations for companies with growth-sensitive revenue streams, including those at many technology companies. In the lead up to the US presidential election, fears of increased restrictions on technology trade between the US and China could also weigh on the outlook. We note that some leveraged and carry-fund positioning has already returned, though not at the extreme levels seen in early August.

Attention will now turn to the US labor market, and Friday’s release of the nonfarm payrolls report for August. Another disappointing jobs report could heighten US recession fears and prompt the Fed to take more aggressive action.

How do we invest?
An uncertain final quarter of the year may augur more equity market turbulence, but we believe investors should keep a long-term perspective, stay the course, and focus on building a balanced and diversified portfolio. We also recommend that investors maintain “shopping” and “disposal” lists to stay disciplined during turbulent times and be prepared to build strategic exposures at more favorable prices as and when volatility arises.

Within technology, we recommend investors examine their AI exposure to align with their longer-term financial goals. We think current volatility may say more about positioning and expectations than about a new fundamental development for the AI trend. Those with low AI holdings should consider building exposure through structured strategies to navigate potential volatility ahead. For those with higher allocations, capital preservation strategies could serve as a hedge.

Investors also need to continue preparing for lower rates as Fed cuts get under way. We expect the Fed to cut interest rates at each of its three remaining meetings in 2024. As returns on cash are eroded, we think investors should consider diversified fixed income and equity income strategies as alternatives to cash.

Finally, investors should maintain diversification across asset classes, regions, and sectors, including alternatives and hedges like gold. Periods of elevated volatility have historically created favorable conditions for select hedge funds to stabilize portfolios and generate strong returns, especially when other asset classes struggle. However, investors should be cognizant of the unique risks of investing in alternatives, including but not limited to illiquidity.