Investors returning from summer vacations might not notice much change in financial markets over the past month. Compared to when I wrote my last Monthly Letter, global equity markets are roughly unchanged, 10-year US Treasury yields are down by around 35 basis points, and the US dollar has depreciated by around 2% against the euro.
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 this letter, I’ll 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.
Although weaker US economic data was a trigger for the recent volatility, we do not believe the US economy is entering a recession. Nevertheless, we do expect the Federal Reserve to respond by cutting interest rates. We now expect the Fed to cut interest rates at each of its three remaining meetings in 2024, with the potential for a 50-basis-point reduction if warranted by a weakening of the labor market or consumer spending. We also believe momentum in the US presidential race has now shifted toward Vice President Kamala Harris.
We are making some changes to our asset class preferences this month. After a strong recent performance from quality bonds, we close 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. In the months ahead, potential cyclical and geopolitical headwinds could contribute to volatility in the technology sector, and may present an opportunity for investors to build up long-term exposure to artificial intelligence (AI) at more favorable prices.
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.
