Markets Under Pressure as Recession Fears Rise

After an extended period of solid performance despite worrisome employment and consumer data, global stocks fell hard on August 5.

The Chicago Board of Trade’s VIX Volatility Index, Wall Street’s “fear gauge,” hit 65, a level not seen since the early days of the pandemic. The general rule of thumb is that a VIX reading below 20 represents expectations for a low-risk environment, while readings above 20 signal expectations for higher volatility.

The VIX tracks the expected 30-day volatility of the S&P 500^® Index. The VIX has been this high only twice in recent history: the COVID outbreak in 2020 and the Great Financial Crisis in 2008.¹

What led up to the market sell-off?

• In July, the market seemed fine on the surface, with U.S. stocks, as measured by the S&P 500, rising 1.22%.²

• Beneath the surface, however, there was a significant rotation from mega-cap technology stocks to small-caps and other areas of the market that have been lagging in recent years.

What drove July’s market rotation?

• The U.S. Labor Department’s inflation measure came in lower than expected in July, which was seen as good news for the prospect of interest rate cuts and a catalyst for rate-sensitive asset classes. It seemed like an indication of a soft landing.

• Sentiment around artificial intelligence (AI) shifted. Investors and companies are starting to question how much is being spent on this technology and whether there’s any return on investment on the horizon. Hedge fund Elliott Management said that Nvidia is in a bubble and AI makes its share price “overhyped.”³

• There’s a potential regime change in the offing for earnings growth. Profit growth for the largest tech stocks is projected to fall from 68% in the fourth quarter of 2023 to 20% in the fourth quarter of 2024, marking a significant deceleration. Meanwhile, analysts predict earnings for the rest of the S&P 500 Index companies will grow from 1% to 11%.⁴

What happened during the week of the sell-off?

• Unemployment ticked up to 4.3%, which was higher than expected.⁵ While we have heard anecdotal evidence about consumers pulling back and manufacturing slowing, this was the first bit of hard data showing that the economy is slowing.

• The Sahm rule, an economic indicator that measures the increase in the three-month unemployment moving average, is flashing warning signs of a recession.

• The yield on the 10-year U.S. Treasury fell sharply. In July, lower rates were viewed positively as an indicator of declining inflation. Now, recession fears are driving lower rates.

• Other issues included a big drop in Intel's stock price, its announcement of 15,000 job cuts and Amazon's cautious comments about consumer spending.

Why did Japan’s stock market fall?

• Japan’s Nikkei Stock Average (Nikkei 225) fell more than 12% on August 5, its biggest one-day drop since 1987. The index has declined more than 25% since hitting an all-time high on July 11.⁶

• The Bank of Japan instituted a rate hike that few expected, coming at a time when most major central banks are cutting rates.

• Financials, especially banks, were among the top decliners in Japan. Stocks tied to tourism and exports also face headwinds as the value of the yen climbed in the wake of the rate hike.
  

What’s next?

• There will still be a lot of earnings news to digest in the next few weeks.

• The Federal Open Markets Committee heads to its September meeting with analysts expecting a cut in the short-term lending rate. The questions now related to how much the Federal Reserve (Fed) will cut and whether policymakers will cut more later in the year.

What is American Century’s view?

The uptick in the unemployment rate aligns with our expectations for a slowing economy. We still see an economic slowdown as the most likely economic scenario with a smaller chance of recession.

We’ll be watching for stabilization in the unemployment rate. We expect a gradual increase in claims, which would indicate normal slowing, but another spike would be viewed as a bad sign. We believe market dislocations like this create opportunities for active managers ready to capitalize on unwarranted moves.

We expect the housing market to improve as interest rates come down. However, it will take time for improvement to become apparent.