Markets resume previously scheduled exuberance

Despite the majority of employers being content with defined contribution (DC) plans, those with defined benefit (DB) plans have seen a shift due to rising interest rates. This means that DB plans require less funding to ensure promised benefits, making them more cost-effective. Meanwhile, in the financial markets, recent volatility has seen a quick recovery, but the reasons behind this and its implications remain to be discussed. Despite being on holiday, market events continued to unfold, leaving some feeling the need to retreat and prepare. While some may have taken extreme measures, others are simply seeking to understand the market's behavior. Stay tuned to learn more about the current state of retirement plans and the recent market fluctuations.

The recent market volatility, triggered by events in the United States and Japan, has raised concerns about the robustness of the current bull market. Despite the market bouncing back after a 6% drop, some analysts are questioning whether the market's gains, which have been largely driven by a small number of highly valued stocks, are sustainable. The fact that half of the total gains in the S&P 500 bull market have come from just 10 stocks, with much of those gains coming from increases in valuations rather than earnings, has added to the unease. This highly concentrated and valuation-driven rally has some observers wondering if the market is in bubble territory. The recent market turbulence serves as a reminder that even seemingly stable markets can experience significant swings, and that investors should remain vigilant and diversified.

Despite a significant market drop, which saw Japanese stocks fall 12% in a day, many risk assets have bounced back and are now back to their pre-crash levels. However, it's important to note that the flavor of this bounce back may not match the flavor of the drop. For instance, defensive stocks, such as utilities, consumer staples, and healthcare companies, have actually performed the best since the beginning of the month. This trend is interesting because these are the types of stocks you would buy if you were looking to minimize risk. The S&P 500 and U.S. corporate bonds have also seen their valuations return to tight levels, which can be seen as a good sign for non-spread specialists. However, it's important to remember that the stocks that are going up the most are the ones that investors traditionally turn to during uncertain economic conditions. While the market may be continuing to rally, it's crucial to keep an eye on the underlying trends and consider the long-term implications of these shifts.

The market has shown signs of risk aversion following the early August crash, but the bounce back hasn't been a return to form. Instead, investors may be taking a pause to lock in impressive returns from the year. One theory behind the market's recent drop is the unwind of the yen carry trade, which involves Japanese investors using cheap yen to invest in US stocks. However, this analysis may oversimplify the situation, as few investors mentioned the yen carry trade as a reason for the market's previous growth. It's essential to remember that finance professionals often use sophisticated-sounding phrases like "carry trade" to make themselves appear knowledgeable. Ultimately, the market's movements are complex, and it's crucial to consider multiple factors when analyzing its behavior.

The recent market volatility may have been overhyped, with investors reacting more to the crowded nature of trades than any significant change in economic conditions. The bond market, in particular, has become more flighty and prone to overreactions. Professor Kevin Calderon of the University of California argues that the US market, with its prevalent use of borrowing to bet on indices like the S&P 500, has adopted the structure of a carry trade. This means that when market conditions start to deteriorate, investors must act quickly to close their trades, leading to potentially amplified market movements. In essence, the market's reaction might have been more about herd mentality than a genuine economic concern.

The global dominance of the US market and the interconnectivity of currencies and investments have created a feedback loop where the performance of the US market can significantly impact the value of foreign currencies and vice versa. This correlation is particularly noticeable with weak currencies like the Japanese yen, but it may be a trend that affects all foreign currencies. With the S&P 500 being a massively owned asset class by investors worldwide, a downturn in this index can create problems for portfolios around the globe. This interconnectedness was not as pronounced 25 or even 20 years ago, and it's essential for investors to be aware of this growing correlation as they make investment decisions.

The summer market shakeout, despite being a single iffy US jobs report, left scars in the form of heightened fear and lowered expectations for economic growth in the rate markets. The markets had become complacent, and the reminder of their volatility serves as a caution. Although the Federal Reserve's expectations remain relatively unchanged, the market is now more jittery, and investors should reset their expectations accordingly. Inevitably, the rest of the year is expected to be more uncertain. Additionally, Rob Armstrong emphasizes the importance of providing typical American workers with access to investment opportunities that have traditionally been reserved for high net worth individuals and institutions. This perspective highlights the potential for generating returns through various investment strategies, including long-short approaches.

Despite having a personal dislike for gold as an investment due to its lack of income generation, the current market conditions may warrant a short-term investment in gold as a safe haven asset during periods of market uncertainty. Conversely, Rob Armstrong has recently gone short on right-wing social media stocks, such as Trump Media and Technology Group, due to their poor performance and the upcoming wind down of former President Trump's stake. Additionally, Katie suggests considering quitting social media platforms like Truth Social and potentially X (formerly Twitter) for personal reasons. The investment world can be unpredictable, and even the most euphoric assets like Bitcoin can experience sudden downturns. It's essential to stay informed and adapt to changing market conditions.

Despite the opposing nature of the trades discussed on the Unhedged Podcast, listeners can find balance by tuning in again. The Financial Times (FT) now offers a new feature, allowing users to access their latest stories and podcasts, including Unhedged, through Apple CarPlay. This convenience is available to those who have already downloaded the FT app and connect their iOS device to their car. For those who don't have the app, it's available for download in the app store. FT Premium subscribers can receive the on-head newsletter for free, and a 30-day free trial is available to everyone else. Additionally, the FT Weekend Festival in London is returning on September 7, featuring talks, tastings, and interviews with popular FT writers and guests. For more information and to purchase tickets, visit the festival's page in the show notes. Unhedged is produced by Jake Harper, edited by Brian Erstadt, and executive produced by Jacob Goldstein, with additional help from Tova Forres. Cheryl Bromley is the FT's global head of audio.