Down Like an Elevator

By: Aaron Anderson, CFP®, CFA, Managing Partner

August 6, 2024

There’s a saying that stocks go up like an escalator and down like an elevator. Over the last few days, we’ve been taking that elevator ride. After a year of doing well and reaching new all-time highs just a few weeks ago, the market is almost in correction territory with the tech heavy Nasdaq Composite Index already there. So what happened?

LPL Research’s Chief Equity Strategist, Jeffrey Buchbinder, CFA postulated that we have a perfect storm that exacerbated the current sell-off. Here is a list of his reasons with my explanations:

Weak Economic Data: Last week saw a batch of weak economic data that increased concerns that the Federal Reserve may have held interest rates too high for too long. I mentioned in my beginning of the year article that the Fed has a dual mandate of stable prices and maximum employment. After high inflation over the last few years, it appeared they were succeeding in both while avoiding a recession. However, they don’t want a repeat of the 1970s when they lowered rates too soon after they thought they had inflation under control causing horrible inflation at the end of the decade. The fear is they waited too long this time making a recession more likely.
Stretched Valuations: The stock market tends to be forward looking. For example, the market usually begins to recover before a recession ends. In this case, the market has essentially gone straight up since last October and is up about 50% since the lows of October 2022. It’s almost doubled since the Covid lows! Many times this can be justified by earnings growth. If a stock price doubled but a company’s earnings tripled, then a stock is cheaper relative to the earnings produced even though it’s twice as expensive. Nvidia has been a recent example of this concept in action. But, price increases can also be caused by…
Market Sentiment: To use a colloquial term, things had become “frothy”. The market had been going up for so long that people feel richer, they want to invest more to participate in it, and so prices get out of whack relative to company fundamentals (note this can happen on the downside too!). Like getting soda from a fountain, the cup appears full, but some of it is froth which eventually dissipates.
Yen Carry Trades: This is obscure. The concept is that people borrow money in a currency with low interest rates (in this case, the Japanese yen) and invest it in other assets with a higher yield. This could be simply converting to dollars to buy higher yielding US Treasuries or using the money to buy high-flying, US tech stocks. Anything to upset that – in this case, the Bank of Japan raising rates – can cause an unwinding of positions which means a selloff in those higher yielding assets.
Seasonal weakness: We are in the historically weak months of August and September. So, when there are reasons to sell, the damage can be exacerbated simply because of the time of year it occurred. There are valid reasons for why this tends to happen, but no reason why it must happen. Nevertheless, it has become expected to the extent that it is often a self-fulfilling prophecy.

Despite how horrible the last few days have been, the market is only back at levels from May – just three months ago. It’s common to have pullbacks in the market during the year. In fact, this year of going almost straight up is the anomaly.

If you’ve been reading my articles, you already know that. As of the time of writing this, nobody has called with any concerns over the last week and I applaud you for it. If not for the speed of this pullback, I’d likely not have bothered writing this newsletter article. Why write about a normal occurrence?

In the short term, I don’t know when the selloff will stop and/or when the market will recover. Due to seasonality factors and the upcoming elections, it could be mid-October to November. Or it could be next week, next year, or longer. As I’ve said previously, this is the “entrance fee” to participate in the historical outperformance the equity markets have given over the long term.

As always, if you do have any questions or concerns, please feel free to reach out to discuss.

Content in this material is for informational purposes only and not intended to provide specific advice for recommendations for any individual. All performance referenced is historical and is no guarantee future results. All indices are unmanaged and may not be invested into directly.

The Standard & Poor's 500 Index is a capitalization weighed index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market.

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing includes risks, including fluctuating prices and loss of principal.