Global markets have been whipsawed by a series of sharp blows in the last few days, mainly centering around concerns about the health of the U.S. economy. Our view remains that the strength of household and corporate balance sheets implies recession is unlikely, but we acknowledge that risks are building. To help decipher and contextualize the current market reaction, Chief Global Strategist, Seema Shah, and Equities Chief Investment Officer, George Maris, provided some clarity into the current situation and their expectations for the remainder of 2024.

Key Takeaways

  • The July U.S. jobs report showed weaker-than-expected job growth, raising concerns about a potential economic slowdown. However, the data is volatile, and it's unclear how much of the weakness was due to temporary factors.
  • The rise in the unemployment rate has triggered a recession signal based on the Sahm Rule. Still, the underlying data suggests that labor market weakness may differ from past recessions.
  • Depending on how the economic data evolves in the coming months, we expect that the Fed will cut interest rates by 75bps, in three 25bps cuts, by the end of 2024.
  • The market has been highly vulnerable due to technical factors like momentum trading, leverage, and crowding in specific sectors, most notably big tech. This has led to significant market volatility that is expected to continue in the near term.
  • The economic backdrop remains uncertain, and incoming data should be closely monitored, but a soft landing is still the most likely scenario should consumer and corporate balance sheets remain strong.
Seema, could you please explain the current macro picture and the market’s reaction to the most recent jobs report?

Seema Shah (SS): Market weakness had been underway for a few weeks prior to July's jobs report. The market was already on edge given the fairly weak numbers from the recent ISM Manufacturing Report, jobless claims, and the Bank of Japan's more hawkish than expected rate hike decision. Notably, while the market expected a 175k increase in payrolls, the July number was meaningfully weaker at +114k. It was a clear downside surprise, but, in context, 114k is not that bad of a number. Typically, anything 150k or above is consistent with a solid economy. While the number was below that mark, it's not consistent with recession by any means — instead, it suggests a slowing economy, which investors already knew. Yet as markets tried to decipher where payrolls would be over the next few months, they extrapolated a downward trend and interpreted the latest data as a signal that recession is on its way.

What does the current situation look like from your perspective, George?

George Maris (GM): Equity markets were already in a precarious position before the recent volatility. There were several risk factors present, including a historically unhealthy concentration in a narrow portion of the market, particularly large-cap growth stocks; extremely low volatility, with the VIX tripling from its earlier lows; uncharacteristically strong inflows into equity markets, setting up a vulnerable technical situation; and systematic trading strategies hitting their limits and being forced to sell, exacerbating the downward pressure.

In addition, many investors had been heavily leveraged in the yen carry trade, borrowing yen to invest in higher-yielding assets like semiconductor stocks and the Magnificent Seven. As a hawkish BoJ met weak U.S. economic data, the yen strengthened against the dollar, causing this trade to unravel rapidly, leading to forced selling that further pressured crowded trades. This type of leverage and speculative positioning had made the market structure concerning, and we expect elevated volatility to continue as these technical factors get resolved. However, we see this as an opportunity for active managers to take advantage of indiscriminate selling and find attractive long-term investments.

Do you see the August jobs report as the start of a trend, or an outlier?

SS: We aren't jumping on the panicked bandwagon because we know payroll numbers are incredibly volatile, often flipping back and forth from month to month. We wouldn’t be shocked to see the numbers rebound next month, particularly because it has been difficult to separate what is a hurricane-related drop in jobs growth and what is a fundamental weakening in the labor market. As it stands, ~50% of Wall Street expects the August jobs report to see a rebound because they're allocating much of July’s weakness to Hurricane Beryl. Part of the market reaction was also due to a rise in the unemployment rate from 4.1% to 4.3%, which triggered the Sahm Rule. This rule indicates a recession if the three-month average unemployment rate rises by 0.5% over 12 months. However, this time, this recession signal may be weaker than it appears because it typically applies when unemployment rises due to layoffs. Today, the increase largely stems from a growing labor force, not job losses, so it doesn't necessarily signal recession.

Do recent events change the path of Fed policy for the rest of 2024?

SS: Just six weeks ago, some in the market said that there would be no rate cuts this year because the economy was so strong! Up until Friday (August 2), market pricing saw 50-75bps of cuts this year. Now, expectations have shifted to a 50bps cut in September, a 25/50bps cut in November, and a 25bps cut in December. This is a major shift in the narrative and a meaningful deterioration from where we were even just a week ago.

From our perspective, the Fed does not need to ease policy so aggressively. If the August jobs report returns to more normal territory, we expect a 25bps cut in September, a 25bps cut in November in recognition that market sentiment has taken a meaningful hit, and a 25bps cut in December. However, if the August jobs report confirms that there is a fundamental weakening in the labor market, then a 50bps cut will become our baseline scenario for September.

There has been some limited speculation in the market about an inter-meeting cut, ahead of the September meeting. Historically, inter-meeting cuts only happen if credit spreads are blowing out significantly or a financial crisis is unfolding, of which there is little sign. However, given that the VIX spiked, some concerns are lingering in the market. If that were to persist, it could signal looming financial system risk and an interim meeting cut could be possible — but that is a very unlikely scenario at this stage.

GM: Regarding Fed rate cuts, I would warn that if they are in response to unfolding recession or financial systemic risk, they are not necessarily a positive catalyst for markets. The average downdraft after the first Fed cut is over 20%, lasting nearly a year. So when the Fed starts cutting, especially if it is in response to weakening economics, it is not an all-systems-go signal. Ideally, the economy continues to slow only modestly and the Fed cuts rates to ensure it can pilot a soft landing. If that is the case, then markets can perform well.

Are there any other market conditions that investors should be aware of?

GM: The level of crowding in Big Tech has become dangerous and in recent weeks, markets were becoming increasingly concerned with Big Tech earnings reports for Q2. While Big Tech companies have not reported bad numbers, with absolute growth and profitability remaining strong, markets had elevated expectations that required the companies to be spectacular to continue the upward momentum. As more data becomes available, expect the market to reset expectations around the real growth potential of these companies. Big Tech is still a secular growth area, even if they may no longer be benefiting from unbridled enthusiasm.

Ultimately, do you see the current economic situation culminating in a hard or soft landing?

SS: Although the job market data has been slowing and recent weak data has increased recession risks, the current economic landscape doesn't raise major concerns, as the fundamentals remain solid. With strong household balance sheets supporting ongoing consumer spending and robust corporate balance sheets maintaining healthy profit margins, we don't anticipate a significant worsening in the job market whereby modest economic weakness transitions to a hard landing. Our baseline expectation is that recession will be avoided.

Even so, the depth of the negative narrative now implies that an imminent full market recovery is unlikely. Investors should pay particular attention to the August jobs report, as it will provide crucial insights into the labor market's trajectory and the appropriate policy response from the Fed. This data will be instrumental in making informed investment decisions in the face of market turbulence, which we see as creating opportunities for disciplined, active investment strategies.

Macro views
Equities
Disclosure

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations. 

Risk Considerations
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision. Inflation and other economic cycles and conditions are difficult to predict and there Is no guarantee that any inflation mitigation strategy will be successful. Equity investments involve greater risk, including higher volatility, than fixed-income investments.

Important information 
This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice. The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account.   

All figures shown in this document are in U.S. dollars unless otherwise noted.  This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. 

This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. 

This document is issued in: 

  • The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission. 
  • Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (Ireland) Limited (“PGII”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGII, PGIE or PGII may delegate management authority to affiliates that are not authorised and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID). 
  • United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorized and regulated by the Financial Conduct Authority (“FCA”). 
  • United Arab Emirates by Principal Global Investors LLC, a branch registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as a representative office and is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation. 
  • Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. 
  • Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission and is only directed at wholesale clients as defined under Corporations Act 2001. 
  • This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH. 
  • Hong Kong SAR (China) by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission. This document has not been reviewed by the Securities and Futures Commission. 
  • Other APAC Countries/Jurisdictions, this material is issued for institutional investors only (or professional/sophisticated/qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. 

Principal Funds are distributed by Principal Funds Distributor, Inc. 

© 2024 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Asset Management℠ is a trade name of Principal Global Investors, LLC.  

3780554

About the author