What Happened in Stock Market on Monday and Its Lessons

11 Aug 2024 , 05:02 PM

Earlier this week, the Japanese equity market lost more than a tenth of its value in a single day, marking its sharpest fall in nearly four decades. The carnage that began in the East then spread to most other markets, including India, Europe, and the US.

While it was a risk-off sentiment that made investors move out of the relatively riskier asset class of equities, other asset classes also took their share of the beating. India’s benchmark Nifty 50 slipped more than 3% intraday on Monday, ending down almost 3% just days after hitting its all-time high of more than 25,000 points.

So what really happened? Let’s understand the four major reasons:

1. An Interest Rate Hike in Japan

• Japan’s currency, the yen, has been strengthening for some weeks now, and the Bank of Japan’s decision to raise interest rates further stoked this rally, making the yen even stronger against the dollar.
• Interest rates around the world have been on an uptick over the last few quarters in an effort to curb inflation post the COVID-19 pandemic. Yet, Japan remained the only country with negative interest rates, meaning that investors earn interest for borrowing funds from and in the country.
• This, in turn, has kept Japan’s currency weak for a prolonged period, which is beneficial for the country given that it is majorly export-oriented.
• Given that Japan was the lowest-cost option for borrowing, with zero interest rates for more than two decades, many funds in the US borrowed money from Japan for investing.
• This practice, known as carry trade, involves borrowing funds from a country with lower interest rates and a weaker currency to invest in a country that can potentially offer higher returns.
• Against this backdrop, the policy rate hike by the Japanese central bank has changed the dynamics of investing with borrowed money, especially as it comes at a time when expectations of global interest rates trending lower are on the rise.
• Investors now need to pay 25 basis points more on their funds borrowed from Japan and are hence looking to close these loans. These loans are being closed by selling off their investments (including in the US and other countries), leading to a sharp drop in their values.
• This practice is also known as reversing these carry trades, and a significant impact of the unwinding of these trades was seen in the US markets.

2. Fears of a Recession in the US

• A weaker-than-expected reading of the jobs data in the US last week has stoked fears that the US economy, the world’s largest, could be headed for a recession.
• The labour market data for July showed that the country added a lower-than-expected 114,000 jobs during the month, while the rate of unemployment rose to 4.3%, increasing for the fourth month in a row.
• This dismal data has also led to fears that the central bank in the US, the US Federal Reserve, has kept interest rates in the country high for too long and may now have to take a higher-than-expected or emergency rate cut, which reduces the scope for a soft landing.

3. Geopolitical Worries

• Even as financial markets around the world have grappled with tension from Russia and Ukraine for several months now, fresh worries have surfaced due to developments between Iran and Israel.
• Not only do these developments impact various asset classes, but they also tend to make investors move their money towards assets that are generally seen as less risky, including fixed-income instruments.

4. Valuation of Indian Equities

• For a long time now, experts have been cautioning about the valuations of the Indian equity markets, especially considering that the growth in earnings or the fundamentals of the market are yet to catch up with the rally in domestic shares.
• Even after the recent fall, the Nifty 50 is up nearly 11% so far in 2024. This follows over 20% gains in 2023 and more than 4% gains in 2022.
• While the Indian economy has been among the few large economies showing growth in high single digits over the past few years, this has led to robust inflows and high valuations for the equity markets.
• Experts believe that these valuations have remained high for an extremely long period, and investors and traders have used the volatility in global markets as a trigger to take some profits off the table for now.

Lessons from the Market Volatility

• Diversification is Key:
  • Spreading investments across various asset classes and geographic regions can help mitigate risk. Diversification ensures that poor performance in one area doesn’t overly impact the overall portfolio.
• Avoid Panic Selling:
  • Market downturns can trigger emotional responses leading to panic selling. It’s important to stay calm and avoid making hasty decisions based on short-term market movements. Sticking to a well-thought-out investment plan is crucial.
• Regular Portfolio Reviews:
  • Periodically reviewing and rebalancing your portfolio ensures it remains aligned with your financial goals and risk tolerance. Market conditions and personal circumstances change, and your portfolio should reflect these changes.
• Understand the Impact of Global Events:
  • Global economic and geopolitical events can significantly impact local markets. Investors should stay informed about global developments and understand how these can influence their investments.
• Focus on Long-term Goals:
  • Short-term market fluctuations are inevitable. Keeping a focus on long-term financial goals can help investors navigate through volatility without deviating from their investment strategy.
• Value of Systematic Investment Plans (SIPs):
  • Continuing with planned systematic investments, such as SIPs, can be beneficial. These plans encourage regular investing regardless of market conditions, helping to average out the purchase cost over time.
• Quality Over Quantity:
  • During market corrections, focus on accumulating quality assets. Investing in fundamentally strong companies with good track records can provide better resilience against market volatility.
• Leverage Professional Advice:
  • Consulting with financial advisors can provide valuable insights and help in making informed decisions. Advisors can offer guidance tailored to individual financial situations and goals.

These lessons underscore the importance of a disciplined and informed approach to investing, especially in the face of market uncertainty.

FAQs

1. What caused the sharp fall in the Japanese equity market?

• The sharp fall was primarily due to an interest rate hike by the Bank of Japan, which strengthened the yen and impacted global carry trades.

2. How did the interest rate hike in Japan affect global markets?

• The rate hike led to the unwinding of carry trades, causing investors to sell off their investments in various markets, including the US and India, leading to a global market downturn.

3. Why are fears of a US recession impacting global markets?

• Weak job data from the US raised concerns about an impending recession, which could lead to emergency rate cuts by the Federal Reserve, further unsettling global markets.

4. What geopolitical worries are affecting the financial markets?

• Ongoing tensions between Russia and Ukraine, along with new concerns involving Iran and Israel, are driving investors towards safer assets, impacting market stability.

5. How can diversification help in mitigating investment risks?

• Diversification spreads investments across various asset classes and geographic regions, reducing the impact of poor performance in any single area on the overall portfolio.

6. Why is it important to avoid panic selling during market downturns?

• Panic selling can lead to hasty decisions based on short-term movements. Staying calm and adhering to a well-thought-out investment plan helps in maintaining long-term financial goals.

7. How often should investors review their portfolios?

• Investors should periodically review and rebalance their portfolios to ensure alignment with their financial goals and risk tolerance, considering changing market conditions and personal circumstances.

8. How can professional financial advice benefit investors? Financial advisors offer valuable insights, personalized strategies, and objective perspectives, helping investors make informed decisions and avoid common pitfalls.