Markets in Asia Pacific saw broad-based selling with Japanese equities experiencing the sharpest sell-off in the region, with the Nikkei 225 index down more than 12% partly because of the yen’s sharp gains. Tech-driven markets like Taiwan and South Korea also fell by more than 8%.
That said, the Nikkei 225 Stock Average and Topix rebounded more than 10%, the most since October 2008, as exporters such as tech companies and automakers surged after the yen slumped about 1% against the dollar.
The MSCI Asia Pacific Index jumped as much as 3.9%, heading for its best day since November 2022, following a rout of more than 6% on Monday.
The recent market weakness did not happen overnight, says Vasu Menon, managing director, investment strategy at OCBC. “It has been happening gradually and picked up pace in the past few days. After the strong gains in the first half, a short-term correction is not a surprise, and we are seeing it at play now.”
However, this may not mean “game over” for medium- to long-term investors, adds Menon in an Aug 6 note.
See also: Japan stocks rebound more than 10% after plunge into bear market
The first trigger for the recent selling, which “really started around mid-July”, was the tech rout after big tech earnings missed forecasts, says Menon. Concerns also emerged about the huge capex for artificial intelligence (AI) not yielding sufficient returns.
Secondly, investor positioning has been crowded, says StashAway CIO Stephanie Leung in an email to customers on Aug 5. “This means that many investors have been piling into the same trade — for example, taking a short position on the Japanese yen versus the US dollar, or a long position on AI stocks. Crowded positioning makes the market vulnerable to sharp moves if they are unwound.”
The sharp appreciation of the yen, following the Bank of Japan’s unexpected rate hike last week, contributed to a rapid unwinding in these positions — and in particular, the yen “carry trade”, a strategy that involves borrowing in a currency with a low interest rate and investing in a higher-yielding asset.
See also: Goldman Sachs economists lift US recession risk forecast to 25%
“The unwinding of these trades triggered a chain reaction across global assets, leading to other crowded positions also being unwound,” adds Leung.
Finally, weak US economic and jobs data released last week led to recession fears and concerns that the US Federal Reserve is behind the curve in cutting rates.
Goldman Sachs economists have increased the probability of a US recession in the next year to 25% from 15%, but said the Fed has a lot of room to cut interest rates and can do so quickly if needed.
OCBC’s Menon points to the Sahm rule, named after former Fed economist Claudia Sahm, which has an “almost perfect track record” of predicting a recession. The Sahm rule states that if the jobless rate, based on a three-month average, is a half percentage point above its lowest point over the previous 12 months, the economy has tipped into a recession.
This indicator flashed red for the first time in over three years last Friday. However, Menon thinks the rule “probably doesn’t apply right now”. “The US economy may not be in recession, given that the increase in the latest July unemployment rate has been due to strong growth in the labour force and much slower employment growth, rather than mass layoffs… So, the rise in unemployment may be due to more labour supply rather than just weaker demand for workers.”
At this juncture, it is too early to call the market bottom given “multiple moving parts and the momentum of selling”, says Menon. “However, the key question to ask would be whether the economic and earnings outlook has changed materially. For now, it’s too early to jump the gun. We will have to monitor economic data in the coming weeks to see if recession fears are indeed warranted.”
OCBC’s base case remains for a soft landing of the US economy, he adds. “So, there is no reason to panic and no evidence to show that the US economy is in any kind of deep trouble.”
See also: Bank of Japan under fire for rate hike timing after market meltdown
‘Keep calm’
The July employment figures may give Fed officials cause to believe that their policies may be cooling the labour market too much, says Menon. “However, we will have to monitor more incoming US economic data to get a better feel.”
With six weeks to go before the next Fed meeting on Sept 18, OCBC expects the Fed will initiate a 25 basis point (bp) rate cut, and only ease more aggressively by 50 bps if August’s data is similarly weak.
The Fed may cut again by 25 bps in November as insurance against a recession but if inflation stays solid, Menon thinks the Fed will wait until December.
Menon urges investors to “keep calm”. “Pullbacks ranging from 5% to 11% in markets are healthy, reducing risks of over-extended expensive valuations over the long run.”
Investors should not get carried away by the sharp rebound, he adds. “The Japanese market has seen a sharp sell-off so the rebound may be technical and there is a risk that the market can still run into turbulence if the yen strengthens more.”
US data in the coming weeks could also contribute to volatility if it shows weakness in the economy, says Menon. “So, investors should not be complacent and it’s best to buy gradually for those looking to buy the dip.”
It is important to “take a step back and look at the bigger picture” during times like these, says StashAway’s Leung. “Prior to this correction, global equities were up more than 13% in the year to end-July. After Friday’s correction, they were still up nearly 10%.”
Much of these gains were also driven by high-flying AI stocks, Leung adds, with the Magnificent Seven up as much as 51% this year. “Given the market’s substantial gains, this correction can be seen as a natural and healthy development.”
Leung says: “If you’ve been hesitant to invest because you thought the markets were too high, now might be a good time to consider entering. Buying during a correction lowers your average entry price overall and can enhance your long-term growth potential.”
But this is not a call to “time the market”, Leung adds. “No one can predict the exact bottom, and attempting to do so often leads to missed opportunities. History has shown that markets tend to rebound, and those who stay invested are more likely to benefit from these recoveries.”
Photo and charts: Bloomberg
