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Investors returning from summer vacations might not notice much change in financial markets over the past month. Yet August saw both the largest one-day points fall in Japanese market history and the VIX volatility index spike to its highest level since the onset of the pandemic. This month has also seen a change in the polling around the US election.
All of this raises questions about whether we are at the start of a bigger shift in the trajectory for markets, economies, politics, and interest rates. In our latest monthly letter, we focus on three topics: What’s changed over the past month and what it means for the outlook; what the recent volatility teaches us about investing and how to navigate such turbulence in the future; and how to bring both together into a robust investment strategy for the current environment:
The case for Fed rate cuts has strengthened. A more mixed set of US labor data showed that the Federal Reserve now has both the imperative and the leeway to cut interest rates, in our view. US unemployment rose to 4.3% in July, and consumer price inflation slowed to 2.9% year over year. We now expect the Fed to cut interest rates at each of its three remaining meetings in 2024, but think market fears of a US recession are overdone. As returns on cash are eroded, we think investors should consider diversified fixed income and equity income strategies as alternatives to cash.
The probability that Vice President Harris becomes US president is rising. National polls (based on FiveThirtyEight.com) now give Harris around a three-point advantage over former President Donald Trump. We recently adjusted our probabilities to reflect this momentum shift, assigning a 40% probability to a Harris win with a divided Congress and a 15% probability to a “blue sweep.” While investors should avoid making outsized portfolio moves based on election outcomes, we do see scope to review portfolio hedges, consider adding exposure to gold and the Swiss franc—which can offer defensive qualities in periods of uncertainty—and manage portfolio overexposure to election-sensitive sectors and currencies (like the Chinese yuan).
Growth uncertainty, geopolitics, and quant investing could drive further turbulence. The rise of quantitative trading has added complexity to market dynamics, amplifying market movements. An uncertain final quarter of the year may augur more 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.
This month, we make several changes to our asset class preferences. Following strong performance from quality bonds, we are closing our preference for fixed income and for high-grade (government) bonds within the asset class. We continue to recommend that investors shift excess cash into quality fixed income—including investment grade corporate bonds—to prepare portfolios for lower interest rates. Diversified fixed income strategies can also help enhance portfolio yield.
In equities, we recommend focusing on quality companies. Those with strong balance sheets, competitive advantages, and exposure to structurally growing revenue streams should be well positioned to navigate economic uncertainties.
Elsewhere, we see upside for gold prices and the Swiss franc, both of which can also improve portfolio diversification and insulate against risks. Meanwhile, we move the US dollar to Least Preferred and upgrade the euro, the British pound, and the Australian dollar to Most Preferred.
Market swings in the past month have shown how quickly the focus can shift away from fundamentals. Investors who diversify, have a long-term perspective, and a clear idea of what they plan to buy and sell have a better chance of navigating and taking advantage of such periods of volatility in the future.
Read more in our latest Monthly Letter, “ Catching up.”
