Will the Market Downturn Persist?

India’s key benchmarks, Nifty and Sensex, were down by 2.8 percent. Meanwhile, Japan’s Nikkei dropped by around 14.2 percent, the Topix by 12.2 percent, and Hong Kong’s Hang Seng by 2.2 percent. In the US, Nasdaq futures continued Friday’s decline, falling by 5.1 percent, while the S&P 500 was down by 2.7 percent. Despite the turmoil, Indian markets are relatively stable.

What caused this week’s market upheaval? While some reasons are evident, there’s no definitive answer. It’s akin to wading into the sea and suddenly encountering a sharp drop in the sandy slope.

One major concern is the US market. Last week’s labor report sparked fears that the Fed might be lagging in cutting rates. My colleague Manas analyzed this issue in detail. He pointed out that while a Fed rate cut seemed imminent after the FOMC meeting, a weak labor market report, showing non-farm payroll additions of 114,000 jobs versus the estimated 176,000, spooked markets.

For months, US economic data has been inconsistent, frustrating those waiting for a rate cut. The Fed wants to be certain of an economic slowdown before cutting rates to avoid backtracking and losing credibility. Post-COVID, the Fed’s delayed response to rising inflation led to the current rate hike cycle. Now, the Fed risks being too slow to cut rates, which could trigger a recession. According to an ING note, the unemployment rate rose to 4.3 percent, triggering the “Sahm rule,” indicating a recession when the 3-month moving average of the unemployment rate rises 0.5 percent above the low of the previous 12 months.

This fear, combined with the BoJ’s tightening stance, caused the Nikkei to collapse into a bear market. The yen carry trade, a term familiar to those who witnessed the 1998 crash in Asian markets, came into focus. This trade involves borrowing in yen to take advantage of low interest rates and investing elsewhere for higher returns. When markets falter, this trade unwinds, causing capital outflows. Although the BoJ has been tightening monetary policy for some time, the recent rate hike was unexpected, driven by inflation concerns due to a weakening yen, as noted in a Reuters report. The yen’s rise, fueled by US labor market data, has stoked recession fears.

How real are these fears? Robert Armstrong, in the FT’s Unhedged column, suggests that these fears may be overblown. He notes that July’s labor market data might revert to the mean in August and highlights strong earnings in the June quarter.

Retail investors should remember that predicting market trends is challenging. In a bull market, not investing leads to opportunity loss, while in a bear market, investing risks real losses. Recent market warnings following events like the pandemic, the Russia-Ukraine war, and other crises saw markets bounce back. However, the advice remains the same in both bull and bear markets.

Review your portfolio’s asset allocation between equity and debt, and within equities, assess the risk in categories like small or micro caps. High-risk themes like semiconductors or AI, which led to a rally in US tech majors, are now faltering. Evaluate your portfolio’s concentration in sectors or themes with long-term gains. Consider your withdrawal timeline and adjust your asset allocation and risk accordingly.

Experienced investors may seem overly cautious, but history shows that severe market crashes can lead to substantial losses. Preserving wealth is crucial for compounding to work in your favor. While you might miss out on some short-term gains, ensuring you’re prepared for a potential deep bear market is essential. Avoid blindly following the ‘buy the dip’ advice. Consult a financial advisor, preferably one with experience or thorough knowledge of bear markets, to avoid common mistakes.