Leadership in Focus

There’s an easy narrative to be told about recent market turbulence. It says that the jitters we saw in late July and early August were merely the reflection of traditional summer illiquidity. Traders on the beach saw that Goldman Sachs had increased their estimates of the likelihood of a US recession and panicked (FWIW, Goldman just managed that estimate back down post US retail sales and jobs numbers…) Or, as I wrote just as the first tremors were being felt in the markets, there was a lot of fast money concentrated in two key areas: the JPY carry trade and Mag 7 stocks. The unwind of the former led to a period of weakness in the latter. Now we’re back to where we were, with a return to a world of soft-landing optimism and AI-fueled excitement. A brief perusal of the S&P500 would seem to confirm this thesis.

I think there’s an argument that you don’t experience the kind of volatility we have witnessed over the past few weeks without it being indicative of deeper-moving currents. My friend and colleague Ed Cole pointed this out in our markets meeting this week – there appears to be the first stirrings of a subtle but unavoidable shift in leadership. If we look at the extent to which different elements of the market have recouped their recent losses, a pattern becomes clear. I rank them here from those that recovered the least to those that have recovered the most. SOX, by the way, is the Philadelphia Semiconductor Index, a useful proxy for the Mag 7.

What can we draw from this analysis? Firstly, I'd point out that, before the wholesale capitulation of early August, we were beginning to see the first suggestions of a move from a prolonged episode of concentration to a more broad-based period of performance. You can see this in the chart below, which compares the July price movement of the SOX with the Russell 2000 index.

It may be that the ructions of August merely interrupted the playing out of a broader market rotation. Or it may be that they precipitated them. One way of reading the moves we’ve seen in markets over recent months is that fast money pulled out of both the yen carry trade and the Mag 7 just at the point that a more significant shift was taking place in the markets. It looks to us as though the fast money has returned to the Mag 7, but that there is still – as the chart below illustrates – the sense of another dynamic in operation (ASX is a global all-share index).

The fast money proved itself evanescent in the face of selling pressure in recent weeks; it may be that the run up in the Mag 7 has even less behind it in the post-volatility era.

It all brings us back to one of my favorite topics: regimes. As the inflationary regime shift played out over the past few years, you might have imagined that the growth/value dialectic never existed. Now people are talking about growth and value again. It's not a simple narrative: falling rates benefit growth as future cash flows are discounted at lower rates; a weakening economic picture might support value (or at least the more defensive elements of the value universe). If a change in leadership really is taking place, it's doing so against an economic backdrop that is not wholly supportive of such a move (which to my mind makes it all the more interesting). One to watch closely in the weeks ahead.