iShares Summer Road Report: top advisor questions of the season

As kids return to their desks and trade summer freedom for textbooks, the markets are shaking off their vacation vibes and getting back to business. The summer months gave us a lot to talk about - from rising volatility to what the rate path could look like for the rest of the year. Here are our views on the common questions advisors are asking as they head back to their classrooms portfolios.

On August 5^th, markets fell into a dramatic tailspin, with the S&P 500 suffering its worst day in nearly two years, dropping nearly 2%.¹ The downturn was primarily fueled by a combination of disappointing macroeconomic data, overstretched systematic positioning, and poor market liquidity.

The market turmoil was exacerbated by the unwinding of the Japanese yen carry trade, where investors borrow the low-yielding yen to invest in higher-yielding assets. The Bank of Japan had strengthened the yen by raising interest rates by surprise, making the trade strategy less profitable and eventually forcing margin calls. A perfect storm of panic hit markets Monday morning, causing the Nikkei 225 to plunge over 12%.²

However, since the event, equity markets have been remarkably quick to make up for the loss, to the point where the S&P 500 steadily approaches its all-time high set in July. Despite the rebound, the turbulence left a scathing mark: the VIX registered its highest level since the pandemic and has reopened conversations about investing during periods of heightened volatility.

We believe that markets have overreacted to a few datapoints and have overlooked constructive fundamentals. We will keep our eye on key macro themes, namely the U.S. election and the path of interest rate cuts, as potential catalysts for near-term volatility.

Click here to learn more about how investors can navigate market volatility during times of uncertainty.

For the past year, the Fed has maintained a firm stance on holding interest rates steady to combat high inflation. As we’ve seen headline inflation descend meaningfully towards the Fed’s 2% target – in large part due to decelerating shelter inflation – the focus for Chair Powell and the committee has shifted to their second mandate: promoting maximum employment.

Over the past few months, significant labor market softening has investors feeling uneasy about the outlook on unemployment and economic growth. The concern is warranted: the unemployment rate has risen by almost a full percentage point since the start of last year, and initial jobless claims have ticked up in recent months.

But we believe rates are poised to come down before the trend of a cooling labor market becomes more of a worry. By now the Fed has made it abundantly clear they will cut rates in September – Powell emphasized their pivot during the Fed’s Jackson Hole meeting, citing that the “time has come for policy to adjust.”

But markets are asking: “by how much?”

The answers are mixed. Markets are pricing in a roughly 40% chance of a 50-bps cut in September, and 100 bps of cuts by the end of the year.³ We maintain our view that 75 bps, or three cuts, would be necessary for the Fed to confidently address loosening in the labor market while also acknowledging inflation as remaining above-target.

The prospect of rate cuts could give equity markets a substantial bounce as liquidity grows and investors exit lower-yielding cash positions. However, it is important to note that even after a few cuts, rates would remain in restrictive territory, limiting potential for select areas of the market. The quality factor may be key, especially in a year marked by short-term volatility due to a changing rate environment and election uncertainty.

The last innings of high rates could present opportunities for fixed income investors to consider buying into high yields before they continue to descend. Holding out for the Fed to actually cut rates might lead investors to miss out on potential bond price gains. Additionally, we’ve seen stocks and bonds return to their historical negative correlations, reintroducing bonds as an appropriate ballast for portfolios.