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Our views 20 August 2024

ClockWise: Emotional markets in August

5 min read

Stock markets reflect a wide range of opinions by different kinds of investors. Whilst markets may be efficient at quickly pricing in information, this month’s violent price swings suggest that perhaps markets are becoming increasingly emotional.

The emotional narrative that the US economy is plunging into a recession suddenly emerged following a soft patch of economic data at the start of August and led to a huge volatility spike and a sharp sell-off in equities. The subsequent reversal was equally as dramatic. Global equity prices have now risen over 7% from the lows recorded on 5 August, as reassuring US data and comments from central bank officials eased investors’ concerns.

Global equity prices have now risen over 7% from the lows recorded on 5 August

In our view, this episode reiterates the need for investment strategies that aim to avoid behavioural traps. We entered the sell-off with a cautious view on equities, acknowledging that the macro fundamental picture had become more mixed. However, during this panic, our measure of investor sentiment reached oversold levels (chart 1), signalling that the sell-off had gone too far. We therefore became more positive on equities at lower levels, especially since we believed that the US recession risk narrative was overdone.

Chart 1: Royal London’s investor sentiment indicator and global stock prices

Royal London's investor sentiment became more positive on equities at lower levels

Source: RLAM, LSEG Datastream as at 19 August 2024.

To quote Warren Buffet, “Be greedy when others are fearful”. We use our measure of investor sentiment as a contrarian signal for equity markets.

Stocks have now recovered significantly from their lows and volatility has fallen, with ‘the fear index’ (VIX) now back to 16 – a level below the long-term average.

We’ve highlighted before how markets can be choppy seasonally in August, as liquidity thins out when many traders and investors are away on holiday. The summer lull also makes it harder for equity analysts to be sure about the earnings outlook for the companies they cover, so it’s not surprising that volatility typically rises during this time of year before peaking in October (Chart 2). 

This chapter of intense volatility may be behind us, as investors refocus on fundamentals and corporate earnings, which remain broadly supportive for now. However, we could still see outsized emotional moves due to narratives around Artificial Intelligence, geopolitics, or the evolving outlook on the US elections.

We became more positive on equities during the panic, but the longevity of our view will depend on evolving macro fundamentals, whilst being prepared to lean against market emotions when necessary.

Chart 2: Volatility tends to rise this time of year

Volatility rising this time of year

Source: RLAM, LSEG Datastream. CBOE S&P 500 Implied Equity Volatility (VIX) from 1990 to August 2024.

 

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.