What a summer! In Paris, the summer Olympics have successfully come to an end; in Vienna, three Taylor Swift concerts had to be canceled due to a threat of a terrorist attack. Also, Ukraine attacked Russia on Russian soil, and the tensions between Iran and Israel have led to the US moving more military forces closer to Israel. The heat is on not just geopolitically but also meteorologically. In Zurich, the heat climbed north 30 degrees Celsius (around 90 degrees Fahrenheit). Our Texan readers will probably laugh at such low numbers.

Last but certainly not least, stock markets experienced some heat as well. Above all, the Japanese market became a victim of a massive sell-off. But more on that later.

All of a sudden

Recall the anticipation among US investors for a series of interest rate cuts in 2024. That was last October. However, the reality has been quite different. Persistent inflation and a thriving US economy, according to the Fed and the US Department of the Treasury, prevented interest rate cuts. Plus, investors got too excited about artificial intelligence, the holy grail of economic growth.

The surprising increase in the unemployment rate to 4.3% in the US and the much lower number of jobs created have led to a sell-off in the markets that not even Jerome Powell’s pointer to a first interest rate cut in September could prevent. So... suddenly, the US economy is not doing that well. Nevertheless, the following numbers of a lower Producer Price Index and Core Consumer Price Index detonated the investors’ euphoria.

A struggling US economy can be bad news for other economic areas such as Europe and Asia. With its giant trade deficit, the US is a crucial global consumer. While the threat of heading into a recession for the US is relatively new, most other countries are already in the advanced stages of an economic trough. For example, Germany entered a recession at the beginning of 2024, and Europe isn’t doing fantastic either. Even the success-spoiled Switzerland shows low economic growth of an expected 1.2% in 2024. At least, it is still positive. Nevertheless, the outlook for the European economy cautiously starts to brighten up. Additionally, the European markets show low valuations as the earnings season revealed much of the weakness experienced in the first semester this year, which makes it an exciting place to invest.

Who caused the crash?

While during the first days of August, the markets in general took a hit, one particular market took a big one. Japan's NIKKEI 225 rallied almost thirty percent in 2024 before starting a correction in July, which ended in a crash on Monday, August 5. The crash in the stock market was accompanied by a strengthening of the Japanese yen (JPY) against the USD. The strengthening was due to the Bank of Japan's decision to raise its key short-term interest rate from 0% to 0.1% up to 0.25%. That caused a massive inflow into the JPY due to a highly speculative and risky "carry trade."

At a carry trade, investors borrow money in JPY, where the cost of borrowing is low. They take the JPY, move it into the USD, and invest in government treasury bills, where they get an interest rate of up to 5.25%. The problem is that the currency risk is not hedged, meaning the traders lose if the JPY strengthens.

Furthermore, the strengthening JPY led to worries that Japanese companies will lose earnings because of worse conversion rates for their foreign earnings when moving them into the JPY.

This time is different

The year 2022 was hurtful to equity investors and bond investors. Back then, hiding in fixed income did not prevent investors from losses. Particularly in the investment world, everyone knows you must be extra skeptical if someone says, “This time is different.” Sometimes, that statement is true. One of these times is probably now. However, the reason is not because this time is different but because the last time was different. The expectation of interest rate cuts causes the yield curve to move towards positive territory.

For example, the 10-year treasury yield is almost identical to the 2-year treasury yield, resulting in a yield curve close to zero. A two-year yield surpassing the ten-year is often a sign of an impending recession. However, historical data suggests that the actual downturn typically begins when the ten-year yield exceeds the two-year yield. This is primarily due to the expectation that, in this scenario, the Fed will reduce interest rates, leading to a faster drop in short-term yields compared to longer ones.

However, the US is not the only economy experiencing an inverse yield curve. Europe was and, to some extent, experiences such a scenario, but it is at an advanced stage compared to the US. According to World Government Bonds, 22 countries currently have an inverted yield curve.

The consequence of the yield curve moving into positive territory is that the protection factor resulting from adding fixed income to your portfolio will rise and provide stability to your portfolio. That does not mean there will be no volatility in the fixed-income area, but you can expect longer-term bonds to pay a positive premium in the time factor. Furthermore, we are seeing more and more companies struggling with their debt already, with a tendency to spread further. Therefore, once again, keep quality high if adding bonds to your portfolio.

The US dollar’s gravity

In times of turmoil, the USD serves as a haven. There are different reasons for that. One is that most investors measure their portfolios' performance in USD. Therefore, if things get rocky, the ones who lose their head will quickly sell off their holdings and move them into the USD. However, this time was different. The sell-off at the beginning of August has led the USD to drop in general but extraordinarily against the JPY and the Swiss Franc (CHF). We elaborated on the reason for the strong JPY above. The reason for the strong CHF is less apparent. One explanation is the heated situation in the Middle East. The potential outbreak of an official war caused the US to move its ordnance closer to Israel. As we all know, a war isn't cheap, ever. Therefore, considering the US being involved in another war will tremendously impact the already high government debt.

On a broader level, the overall weakening of the USD, which the USD index "DXY" shows, is due to the expectation of decreasing interest rates starting in September at the latest. While the other national banks, such as the Swiss National Bank, the Bank of England, the Bank of Canada, and the European Central Bank, will probably lower their interest rates too, the difference to the Fed is that they already started doing so. Accordingly, the impact of an interest rate decrease by one of the banks mentioned will be smaller than the Fed's decision on a first interest rate cut.

Chances are that there will be a counter movement. Due to the quick weakening of the USD, a strengthening of the USD would not be surprising. However, as mentioned many times, the long-term trend of a weakening USD is intact.

From Au to He

Did you like chemistry? You may remember the periodic table of elements. Did you know that gold is one of the elements shown on that table, as is silver? Do you also remember what element is on the top right? 

Correct, it is Helium (He). 

Apologies for the digression. However, the gold price brought Helium to mind, a substance so light that it ascends straight to the sky. While we encounter numerous arguments that support our view of a consistently rising gold price (such as geopolitical tensions and high government debt), our historical experience tells us that this is not a linear progression. Despite the rally of gold, we believe it is trading at a fair level but carries the potential for a correction. As for silver, often referred to as gold's 'little brother,' we have already witnessed such a correction. However, for silver, this correction is logical as it is not just a precious metal but also an industrial one.

While we stay positive on precious metals, we must recognize the market forces. Therefore, a further increase in the gold price would represent an opportunity to rebalance your portfolio, realizing some gains. A correction, on the other hand, offers the chance to start building a position or repurchase the sold precious metals to rebalance them again. Such a decision should always be made considering your overall wealth structure.

Don’t get confused

In the investor's world, sometimes, the good news is bad news, the bad news is no news, and the good news is good news. The interpretation of the investor's world is always an ensemble of many different factors. Therefore, it is helpful to take a step back and think about the larger picture to avoid getting frustrated. A particular strategy might not bring the expected results in the short term, but it can change quickly. As seen recently at the Nikkei 225, even an index can lose 20 percent within three trading days. Or at the Russell 2000, which gained about 11 percent at the beginning of July. However, the trend has become clear: central banks will decrease interest rates, and the Fed will follow soon.

Furthermore, there is more doubt about the forecasted soft landing. The actual outcome is less important as the traders always position themselves in the expectation of the future. Therefore, even if you sit deeply in a recession, the expectations will lighten up, and investors will position accordingly.

In summary, it's crucial not to let short-term fluctuations overly influence your decisions. Instead, focus on the enduring patterns of long-term trends, which provide a more reliable guide for your investment strategy.

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