Recent stock market volatility has created questions regarding the sustainability of the current bull market for stocks. Typically, market volatility is inversely related to stock market performance (spikes in volatility are associated with stock market corrections). While most Canadians were enjoying the August long-weekend, global stock markets experienced a sharp correction due to concerns surrounding a U.S. recession and the unwinding of the ‘Yen carry trade’.
U.S. recession concerns have grown due to a recent increase in the U.S. unemployment rate in combination with the view that the consumer is showing signs of fatigue after years of higher interest rates and inflation eroding their purchasing power. This view has been reinforced by recent quarterly results from companies like McDonalds who are stating that customers are pushing back on price increases for their products. After years of being able to pass higher input costs onto consumers, further price increases are beginning to impact sales.
The Yen carry trade is used by institutional investors to borrow Japanese Yen at a very low interest rate and invest borrowed funds in a currency or asset with a higher yield than their cost to borrow. This trade requires borrowing funds in Japanese Yen; therefore, it is susceptible to changes in interest rates, foreign currency levels and relative economic growth prospects. The recent market sell-off was caused by the Bank of Japan increasing its overnight interest rate by 0.25% while the U.S. Federal Reserve guided the market towards interest rate cuts. This relative change in interest rate policy between Japan and the U.S. caused an increase in the value of the Yen relative to the U.S. dollar which, in turn, caused investors to sell stocks to repay their Yen borrowings.
This week’s chart plots 2024 stock market volatility (red dotted line) relative to the average S&P 500 volatility experienced during U.S. election years going back to 1992 (blue line). Notice market volatility tends to peak near the U.S. election in November.
One of my favourite quotes is, “although history may not repeat, it often rhymes”. If past is prologue, investors may want to prepare for higher-than-normal stock market volatility as we approach the U.S. election. This doesn’t mean a larger stock market correction will occur this fall; however, seasonality may not be in the stock market’s favour based on prior U.S. election cycles.
Eric Van Enk is a wealth adviser & associate portfolio manager with National Bank Financial in Medicine Hat. He is a graduate of the University of Calgary, as well as a CFA charter holder with 20 years of financial markets experience in New York, Toronto and Calgary. He can be reached at eric.vanenk@nbc.ca
