Why It Matters

Markets sold off sharply last week, with Wall Street’s “fear gauge” reaching levels seen only during the pandemic calamity, dot-com crash, and global financial crisis. In hindsight, a market shakeout was inevitable: overconfident investors were heavily invested in riskier trades, wrongly assuming they could exit first at a hint of trouble. When AI optimism and hopes of a smooth economic landing started to quiver, and when a yen rally forced investors to unwind their carry trades (borrowing in the low-yield currency to invest in higher-yielding ones), market sentiment nosedived. This led to a scramble for the exits, with feedback loops amplifying losses and reminding everyone just how easily markets can toggle from stability to chaos.

Tech stocks remained under pressure as investors continued to question whether AI's benefits will ever actually outweigh its enormous investment costs. Adding to the uncertainty, Warren Buffett announced that Berkshire Hathaway had halved its Apple holdings. Even Nvidia, the AI darling and the direct beneficiary of those massive investments, didn’t escape unscathed – its share price fell about 30% from the record high it hit in June. Big Tech’s big adjustment has taken some froth off valuations, with the Nasdaq 100 now priced at 24 times the expected profit, down from about 28 times a month ago. This means valuations are more reasonable but these stocks are still far from cheap, hovering well above their ten-year average.

Weak US job data sounded the Sahm rule recession alarm – and helped drive last week's market sell-off. But an update from the US Labour Department on Thursday likely eased some fears, with first-time unemployment claims falling further than they have in nearly a year. The data sparked some hopes that the job market might return to pre-pandemic normality, whilst also highlighting the tricky task of reading the economic tea leaves in the wake of Covid’s many disruptions.

The yen’s recent surge slammed Japanese exporters and prompted investors to ditch the country’s stocks as they unwound their carry trades. This put Japan at the epicentre of the global sell-off, with the Nikkei 225 recording its worst one-day drop since 1987. The market turmoil has forced the Bank of Japan (BoJ) to rethink its interest rate hike plans: it now says it will hold rates where they are until markets stabilise. Hearing the BoJ yield to market pressures might have been music to the ears of investors, but to other central banks, it probably didn’t sound so nice. They make a point of repeatedly reminding folks that market fluctuations don’t carry any sway in their interest rate decisions.