Chronicle - Aug 18, 2024
Investing Amid Market Turbulence
The S&P 500 fluctuated sharply over the past month, driven by two major sentiments: fears of a U.S. recession and the Bank of Japan's (BoJ) interest rate hike.
U.S. Recession Concerns
Over the past few months, U.S. macroeconomic data has been less than stellar. The Consumer Confidence Index, Retail Sales (including autos, repair shops, fuel, equipment, tools, food, and beverages), and Disposable Personal Income have all shown weakening trends, though not drastically.
The most alarming data is the Small Banks’ Credit Card Delinquency Rate, which has reached nearly 8%, the highest since 1990. A significant rise in the Delinquency Rate is often followed by a recession.
Another factor worrying the market is the latest unemployment rate of 4.3%, higher than the expected 4.1%. This increase might be partially attributed to the nearly one million workers affected by Hurricane Beryl in Texas.
Japanese Interest Rate Hike
Last month, the Bank of Japan (BoJ) raised its interest rate to 0.25% from 0.10%. Although the increase may seem small, it represents more than a 100% rise in interest payments for those with Yen-denominated loans.
For over a decade, Yen loan rates have been extremely low, leading many investors to borrow in Yen to invest in riskier assets like stocks, bonds, and real estate. It's estimated that over $4 trillion worth of investments have been financed by these cheap Japanese loans.
This interest rate hike has sparked fears of panic selling among those holding assets financed by these low-cost loans.
Investing Amid Fear
Both of the negative sentiments mentioned above share a common theme: fear (of a recession and panic selling). However, the actual impact may not be as severe as anticipated.
Currently, the U.S. Real GDP growth stands at 3.1%, which is the average level of the past 30 years and far from recession territory, which is typically marked by two consecutive quarters of negative Real GDP.
Moreover, the performance of U.S. companies remains strong. As of last week, 78% of S&P 500 companies reported Q2 2024 earnings that exceeded expectations. On average, their net profits grew by 11.5% compared to the previous year.
Fears of panic selling by investors who borrowed in Yen also seem overblown. While it's true that the Bank of Japan's interest rate hike will significantly reduce their investment returns, these investors are likely to adjust their strategies carefully. The BoJ's rate hike has been anticipated for 1-2 years, even though it was only implemented this year.
Investment narratives will continue to swing from one extreme to another. Investors should stay focused on their financial goals and avoid being swayed by economic sentiments. For example, in the past month, the economic narrative shifted dramatically from concerns about inflation (with the Fed maintaining high interest rates) to fears of a recession (with expectations that the Fed will cut rates). Such abrupt changes are difficult to digest, as the economy typically evolves gradually, not suddenly.
The Right Steps for Investors
Since 1945, the S&P 500 has weathered 12 recessions. An investor who put $10,000 into the S&P 500 index back then would now have over $52 million. This might seem unbelievable, as very few people, besides perhaps Warren Buffett, commit to long-term investing.
However, even in shorter time frames, stock investors can still reap substantial rewards. For instance, an investor who bought into the S&P 500 at the beginning of 2020, just before the Covid-19 outbreak, is now up by 70%, or roughly 12% per year, including dividends. This gain occurred despite experiencing an initial unrealized loss of 30% during the pandemic.
While timing and selecting the right investment instruments are crucial, the most important factor in investing is risk reduction.
There are two main ways to reduce risk: through diversification and regular investing, commonly known as dollar-cost averaging.
Investing in stocks from other countries is a smart strategy, as it can reduce your portfolio risk. Multinational companies have more growth opportunities compared to local companies confined by geographic boundaries.
Additionally, some foreign stock markets, like those in the United States, have strict regulations regarding transparency and insider trading. There is also no market intervention in stock prices, which means investor interests are better protected when investing in established foreign markets like the U.S.
The second way to lower risk is by using dollar-cost averaging, or investing regularly. By routinely allocating a portion of your income to investments, you can avoid the stress of trying to time the market. Even legendary investors like Warren Buffett acknowledge the power of dollar-cost averaging: "Be more aggressive when prices are low and less aggressive when they're high."