We are living in turbulent times and extremes, a period characterised by the Nasdaq slumping 5% over a few days of trading and then regaining its feet; the Nikkei experiencing its biggest drop in 37 years with the index plummeting 12% in a single trading day, then bouncing back 10% to record one of its best days.
Justifiably, bemused investors, looking at a world beset with geopolitical tensions and economic uncertainties and dealing with the ripple effects caused by these volatile conditions, wonder what is driving the material changes in sentiment and whether the events they represent provide an opportunity, a threat, or a finely balanced combination of the two.
Understandably, the outlook will be coloured by a personal point of view. Some will say unpredictable markets mean difficulty timing investments and heightened loss potential. Other investors will see the present volatility as an opportunity and improved chances of acquiring high-quality assets at discounted prices.
When forming a response to these two views, Melville Douglas believes that the answer lies in what has caused the present uncertainty and what the future holds. It is worth pausing at this point and looking at these issues.
As always in retrospective answers penned after events, commentators' narratives have provided mixed views but identified valid issues. These issues range from the ongoing hostilities between Russia and Ukraine to the turmoil and escalating tensions in the Middle East. Other observers blame light summer trading volumes, mixed tech results, investment icon Warren Buffett selling off half his Apple shares, and downbeat reports from consumer-facing companies.
As I said, all are valid, but from our viewpoint, comments ignore the simplest explanation: after a strong rally, the market was ripe for a correction, a rapid and significant drop in its value, usually due to overvaluation or other market conditions. What we are experiencing today is just that, a market correction.
To put it in context, despite a “blip” in April 2024, the world’s indices have risen steadily since October 2023 and, despite the volatility, are still up 24%. We have been experiencing an underlying “Goldilocks” driver — solid economic growth that wasn’t too hot to stoke inflation nor too cold to be a problem for corporate profits.
One of the enabling factors has been the conquest of inflation, which is trending towards central banks' target levels. This can only be viewed as a remarkable achievement when, just two years ago, inflation was running at double-digit levels and fuelling fears of a potential lost decade reoccurring.
This “lost decade” would have rivalled the events of the 1970s when stagflation was spurred by stagnant economic growth, high unemployment, and high inflation. This situation is challenging for policymakers because the usual tools to combat one problem (like raising interest rates to control inflation) can exacerbate others (like worsening unemployment or slowing growth even further).
Instead of this scenario repeating itself, central banks are cutting rates. The European Central Bank (ECB) led the trend in June, the Bank of England followed early in August, and the US Federal Reserve is expected to announce in September.
To put it in context, despite a 'blip' in April 2024, the world’s indices have risen steadily since October 2023 and, despite the volatility, are still up 24%
As always, central bankers will be conscious of the importance of being ahead of the curve when making these and future decisions and building on the fact that there is typically a lag of between 18 and 24 months before the full effect of rate changes filter through the economy.
We believe, however, that the Federal Reserve has acted appropriately. They have allowed themselves the latitude to make the necessary tweaks if continued lower inflation rates leave scope for further policy changes to be introduced more quickly than anticipated. In the Fed’s favour are unemployment rates approaching a record low and the adoption of technologies, including artificial intelligence, that could fuel a future productivity boom, increased efficiency and economic growth.
What is certain in these uncertain days is that understanding these drivers and their implications can be empowering and vital for making informed investment decisions.
As mentioned earlier, we believe that present volatile conditions can be primarily ascribed to a market correction. As often happens, corrections are followed by strong recoveries led by resilient sectors such as technology, healthcare, and renewable energy.
Investors who navigate the turbulence by focusing on long-term fundamentals rather than short-term noise may find themselves well-positioned to capitalise on the eventual market rebound and potentially significant long-term gains.
• Drotschie is chief investment officer at Melville Douglas, the boutique investment management company for the Standard Bank Group
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