Last week saw a surge in market volatility, with the volatility index hitting levels last seen during the US regional banking crisis in March 2023. It is important to note that we have experienced very strong markets with very little volatility over the past 18 months. And while this might have felt like a comfortable ride, it is certainly not the norm for equity markets.
Since the last significant market downturn (which occurred in the third quarter of 2022, when the S&P 500 fell by about 17%), two main themes have driven markets. The first is the transformative impact of AI on economies and businesses. The second is the hope that the US Federal Reserve will achieve a "soft landing" by lowering inflation with higher rates while avoiding a recession. Until recently, this seemed to be unfolding quite smoothly, with the S&P 500 rising by 49% since October 2022.
However, market jitters have emerged over the last few weeks as several major tech companies reported earnings and announced increased capital expenditures related to AI. Critics argue that there is little clarity on when these AI investments will translate into tangible earnings, causing notable share price declines for these companies. Additionally, recent economic data has raised concerns. The latest US manufacturing and unemployment figures suggest that the economy may be slowing faster than the Fed anticipated, prompting fears that the Fed may have delayed rate cuts too long, potentially leading to a recession.
As the Fed’s September meeting approaches, investors are speculating about a potential recession, the possibility of a "soft landing," and future rate cuts. Instead of fixating on these questions and trying to time the markets, investors should remember that, as noted by legendary investor Peter Lynch, more money is lost preparing for corrections than in the actual corrections themselves. In this way, remaining invested in a diversified portfolio of high-quality companies led by strong management teams remains the best course of action during times of heightened market volatility.