Market crash? Why predicting short-term moves is difficult

Last week will provide a good case study into why predicting short-term market moves is so difficult.

The week started with all eyes on Central banks, as investors waited for an expected interest rate cut in the UK, and to hear what the US Federal Reserve was planning.

The Bank of England duly did its part, as it cut interest rates for the first time in four years last week.

This had been widely expected for some time and, as such, the move didn’t elicit a huge change in the FTSE 100. With inflation challenges remaining, future reductions are likely to be gradual.

This decision also came on the back of new Chancellor Rachel Reeves outlining her initial findings from her first few days in the job. In this time, she says she has found a multi-billion-pound black hole in UK finances that will need paying, though this has been challenged by her predecessor Jeremy Hunt. In other words, we are likely to see some form of tax increases in October.

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In the US, the Federal Reserve elected to maintain interest rates for the time being. Federal Open Market Committee (FOMC) chairman Jerome Powell, speaking after the decision, said interest rates would likely be cut in September, and that the US economy had been far more resilient than expected.

Yet by Friday, markets were falling, as weaker than expected economic data and poor results in the US resulted in alarming headlines about a potential recession in the offing.

This was partly caused by job data released on Friday that revealed that just 114,000 jobs were added in the US in July. This compared to expectations of 175,000 jobs. Similarly, unemployment increased to 4.3% – its highest rate in nearly three years.

At the same time, several companies posted disappointing results. For example, McDonalds revealed sales at locations open for at least a year saw sales fall by 1% in the second quarter, compared to the same period last year. There were also drops in the technology sector, which has powered much of the equity growth since the recession. Amazon and Microsoft shares both fell on weak growth. Meanwhile Intel shares plummeted to levels not seen this millennium, after it announced thousands of redundancies and a dividend freeze.

The result of all of this was that, by Friday, the US market found itself in a difficult situation. The NASDAQ ended the week down almost 4%, while the S&P 500 finished down nearly 2%. This meant both indexes finished the week well below where they started.

This may feel like an overaction by the market whilst a number of companies, such as Facebook, continued to perform well. Sentiment could also change quickly if employment data improves next month.

Powell is due to speak at the end of August at the Jackson Hole economic symposium, before the Federal Reserve meets to discuss interest rates again in September. Last week’s event will mean these meetings will take on even more public interest.

Among the worst performing markets last week was Japan. A Bank of Japan decision to raise interest rates on Wednesday led to a strengthening Yen against the dollar. This, combined with the recession fears in the US, created a difficult environment for Japanese companies, and the Nikkei Index fell notably last week. This continued into this week, and the Nikkei Index fell 12% on Monday.

However, Martin Hennecke, Head of Asia & Middle East Investment Advisory & Comms at St. James's Place, notes that international investors will likely have been shielded from some of these falls: “It should be noted that international investors allocating to Japan equity strategies are typically seeing the Japan market drop cushioned by the Yen gain in their portfolios.”

“In any case, we recommend remaining calm and not be prompted into knee jerk reactions by these latest developments. Equity valuations in Japan actually happen to be attractive historically speaking, and it remains to be seen how much more tightening (if any) the Bank of Japan could afford given high sovereign debt levels coupled with the recent market turbulence.”

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When markets suffer rapid falls, it can be difficult to avoid making these knee jerk responses. However, as Joe Wiggins Investment Research Director, says, resisting this is key to long term success.

He says: “Volatility and uncertainty are a feature of equity markets over the short-term. Although it is impossible to consistently anticipate periods of drawdown – we know that they will happen. The real danger of such occurrences is not usually the losses themselves but the poor decisions we are prone to make when they arrive. To deliver good long-term outcomes, following our plans and avoiding emotional responses to periods of stress is absolutely essential.”