Don’t panic. Let’s understand the facts.

The United States share market suffered a considerable downturn on Monday the 5th of August, with the Dow Jones Industrial Average falling 2.6%, the S&P 500 falling 3%, and the Nasdaq Composite falling 3.43%. This occurred on the back of several factors; fears of brewing war between Israel and Iran in the Middle East, growing recession fears in the United States, and the unwinding of Japanese Yen (JPY) carry trades.

The least significant factor was the increasing tensions between Israel and Iran. On Wednesday the 31^st of July the leader of Hamas, Ismail Haniyeh, was assassinated in the Iranian capital of Tehran by Israel. This attack was the latest escalation between the two countries bringing them both closer to all out war with each other. This political uncertainty introduces volatility into the share market which is further exacerbated by Israel being backed by the United States and Iran being backed by Russia, increasing tensions between two major global superpowers.

A more significant factor in this recent sell off has been increasing fears of a recession in the United States. These fears were ignited by the US unemployment rate jumping to 4.3% in July, rising from 4.1% in June. 4.3% is the highest level of unemployment seen in the US since September 2021. This jump combined with a manufacturing PMI of 46.8, indicating shrinking manufacturing activity, spooked investors into believing that the Federal Reserve had been too slow in lowering the central bank rate and was leading the country into a recession.

The leading cause though of this sell off has been hedge funds unwinding Japanese Yen carry trades as the Bank of Japan raises interest rates and JPY appreciates against the US Dollar (USD). Since 2016 Japan has had a short-term interest rate benchmark of -0.1% which was only raised in 0.1% in March of this year. In recent years it has been popular for investors to borrow money in Japanese Yen at a low interest rate and then convert that money into USD to buy US stocks. This has grown even more popular recently as the USD appreciated to be worth over 160 JPY. At the Bank of Japan’s July 30-31 meeting, they decided to raise their short-term rates to 0.25% stating that a further increase was possible later in the year. This increase and statement has led to an appreciation of the JPY to 145 Yen for each US Dollar as well as a 20% fall in the Nikkei 225 from the 31^st of July to the 5^th of August. As JPY has appreciated investors who borrowed in JPY in order to hold stocks in USD now technically owe more than they originally borrowed. This has triggered investors to sell off these investments to pay back their JPY loans before the JPY potentially appreciates even more. This large sell off has been the main component of the recent share market correction.

In order to combat this market retraction and the fears of recession the US Federal Reserve would normally cut interest rates, but if they were to do so now it may make matters worse. If the Federal Reserve lowers interest rates it will lower the demand for the US Dollar, further depreciating it against the Japanese Yen and making the unwinding of carry trades worse.

Despite the recent market turmoil, there are signs of recovery and stabilization. The US Federal Reserve has signalled that it will not rush to cut interest rates, which may ease the pressure on the US dollar and the carry trade unwind. The Bank of Japan has also indicated that it will monitor the impact of its rate hike and act cautiously to avoid further shocks. The Nikkei 225 has rebounded by 8% from its low on August 5th, and the US S&P 500 has regained some of its losses as well. Remember the Chicago Board Options Exchange’s CBOE Volatility Index (VIX), while it is also referred to as the fear index, in our eyes should be considered the uncertainty index, as it only goes up when there is uncertainty in markets and the world. As investors we should be careful of this not to allow emotion to get in the way of our long-term objectives.

In terms of investment portfolio positioning the best way to approach this market downturn is through an appropriately diversified portfolio. Yields on US 10-year bonds fell by 8.8% and two-year bonds fell by 11% since the 30^th of July, if you were holding fixed interest funds in your portfolio much of the impact of the stock sell off would be reduced due to the increase in the price of bonds. The iQ Income/Defensive, FirstChoice, and Retirement portfolios are appropriately positioned to handle such a sell off, with the portfolios not only containing fixed income allocations suited to a variety of risk profiles but also more defensive and income orientated equity funds as well. These portfolios given their lower risk positioning will have a very strong period taking advantage of this volatility which is in line with their designated role in portfolio construction. This is also a good opportunity for our more growth orientated portfolios (iQ Accumulation/Growth, Active, and Low Cost) as this downturn has provided the chance to pick up assets on sale. We can now shift the portfolios to be further growth style orientated, taking advantage of these now cheaper assets and their eventual rebound to achieve strong returns.

We cannot ignore the reality that markets are volatile and unpredictable, and that risks and opportunities can emerge at any time. That is why it is essential to have a professional and experienced investment management team looking after your portfolios, who can adapt to changing conditions and make informed decisions based on sound research and analysis. It is also important to have diversified portfolios, both at the portfolio level and at the asset class level, so that you can benefit from the different sources of returns and reduce the impact of any single factor or event. The team is committed to providing you with the best possible service and advice, and we will continue to monitor the markets and manage your portfolios accordingly.