What now?

August 28, 2024

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Recent market turbulence should offer a sobering reminder to investors that this is not a risk-free environment, writes George Muzinich.

We are experiencing turbulence in the financial markets. But is this really a surprise? We have known for a long time that the rally has been fueled by a binge of excitement in a small number of tech stocks. We have also been fond of comforting ourselves in the optimism of a soft landing, of successfully navigating a course between Scylla and Charybdis.

We liked to think that if markets went up when interest rates were rising, they should surely continue to go up once interest rates are likely to start declining. And so on and so on.

We, however, have preferred to ignore the fact that we are living in a kind of La La Land. Where we can keep printing money at will and, at the same time, keep doling out money without serious reason or restraint. We survived the loneliness and fear of a Covid war, money was cheap, and we had to make up for lost time. Never mind the fact that we are living in a time of two actual wars, in a time of political radicalization, in a time of rising costs due to excessive financial spending.

We must not lose sight of the fact that we have undergone a time of historic distortions. We must not forget that we are still recovering from precedent shattering periods in our economic and financial history. Prior to Covid we lived through a period of negative interest rates, a first-ever in financial history. We then lived through a Covid-inspired time of economic inactivity, which was also precedent setting. We have since then gone through a period of extraordinary economic and financial stimulus to supposedly help us out of our Covid-induced economic slumber.

Jay Powell, the head of the US central bank, was recently quoted as saying, “It’s very much understood by us that we have two-sided risks, and we have to manage them”.¹ In other words, we have to navigate between the risks of recession and inflation. Our concern is that charting the course just right will be difficult.

We fear that it will be difficult to deleverage the economy without creating recessionary pain. We need to come to the realization that there is simply too much debt out there. Our government debt is increasing in alarming proportions. The real estate market in many parts of the country is buckling under the stress of too much leverage. The Wall Street Journal recently stated that, “Investors borrowed like crazy during the rally”.² Bloomberg last month said that “Americans’ past due credit card balances are at the highest since 2012”.³  We gorged on debt during the period of very low interest rates, and we must now live through a period of catharsis.

We need to understand markets in a broad perspective which incorporates the historical changes we have seen in the last 5-to-10 years. But our thinking about valuations has become distorted in the last few years by disruptive technologies of seemingly infinite potential. Artificial intelligence and related technological advances provide exciting opportunities for potentially exceptional returns. We have become suddenly aware of new continents of opportunity and untold riches. But we should also not lose sight of the uncertainties and perils that abound in these visions of new lands of milk and honey.

On August 5, we experienced a frightening day of an equity market meltdown. The Financial Times reported that “almost 90% of stocks on the MSCI All Country World Index had fallen in an indiscriminate global sell-off”.⁴

Even if later in the week the market recovered nicely, we must keep in mind that we are living in a momentum driven market and not one based on compelling valuations. We need to ask ourselves, was that one day of market contraction an aberration in a still smoothly sailing market? Or was it a precursor of more such tremors? We are concerned it may be the latter.

Heightening our concern was the early July Bloomberg announcement that “One of the biggest bears in the bull market is leaving”⁵ or to quote Morningstar “Wall Street’s most bearish strategist is leaving”.⁶ We do not try to predict short-term market gyrations, but there is enormous danger when there is an overall consensus that there is little risk in the market.

References

1. Bloomberg, as of 3rd July 2024
2. Wall Street Journal, as of August 12th 2024
3. Bloomberg, as of 3rd July 2024
4. Financial Times, as of 9th August 2024. “The meaning of the market sell-off”
5. Bloomberg UK, as of 3rd July 2024.
6. Morningstar, as of 3rd July 2024.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of August 2024 and may change without notice.

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