Here’s What Sparked Monday’s Stock Market Madness

Ivanna Hampton: Global markets are rebounding following a wild swing. A sharp selloff closed out trading on Monday, Aug. 5. Just a few weeks ago, stocks were at new highs, but a worldwide wipeout knocked back gains for popular trades and Big Tech. Morningstar, Inc. markets reporter Sarah Hansen has investigated the turmoil. Thanks for being here, Sarah.

Sarah Hansen: Thanks so much for having me.

Hampton: Let’s get into it. The stock market has stabilized after a couple of bad days, especially Monday. What happened out there?

Hansen: You’re right. Yesterday, Monday, was a wild day in the markets, and it wasn’t just one thing that triggered all those losses. A big part of the story this time around has to do with the economy, interest rates, and the Federal Reserve. Last week on Friday, we saw a weaker-than-expected June jobs report. We saw the unemployment rate rise to 4.3%, and we saw a lot fewer jobs added compared to what economists were expecting. That report started to fuel worries among investors that the Fed has actually left interest rates too high for too long in its fight against inflation and has in doing so damaged the labor market, which would leave the door open for a recession.

Now, that’s not the consensus view by any means. Here at Morningstar, our economists say that while the jobs report was certainly bearish, there aren’t yet those super worrying signs that we’re headed for a recession, but nonetheless, investors and markets reacted pretty strongly to that data. And on top of that, we had some serious tumult coming out of markets in Japan, and we had some more fundamental issues surrounding American tech stocks that finally came home to roost.

Hampton: Let’s focus on the Bank of Japan. It recently raised its interest rate. Talk about how that move was a one-two punch for the so-called carry trade and for US tech stocks.

Hansen: This is a really interesting part of the story, and it has to do with the Japanese yen and interest rates in Japan. And I’ll say as a caveat that this is really a professional investor story, this angle. Over the past couple of years, Japanese interest rates have been extremely low, and as a result, the yen has been extremely cheap compared to the dollar and compared to other global currencies. So, professional investors like hedge funds have been borrowing this yen at a discount and using it to fund the purchase of other higher-yielding assets like other global currencies and US stocks, including US tech stocks, which have just seen some incredible momentum over the past year or two and make for a really attractive trade for those professional investors. That’s what’s known as the carry trade.

The problem started when the yen started to strengthen, which made the carry trade a lot less profitable, and it forced those professional investors to start unwinding their positions and start exiting out of riskier assets in order to cover their losses. And then last week, to make matters even worse, a larger-than-expected interest-rate hike from the Bank of Japan only accelerated that unwinding of the trade. And when everyone started to exit their carry trades all at once, it created this ripple effect across global markets, and it caused even more selling, kind of like a snowball. And that’s why we saw a lot of losses accelerate starting yesterday.

Hampton: And the global selloff bruised Big Tech, yet some market watchers have warned that this was coming for a while. What have strategists told you?

Hansen: You’re absolutely right. In a lot of ways, the losses in Big Tech weren’t all that surprising to analysts, and that’s for two reasons. The first is that we’ve had an extremely concentrated stock market over the past year or two, and that means that just a handful of stocks like Nvidia NVDA, Microsoft MSFT, Google GOOGL, and Amazon AMZN have been driving a large, large portion of the entire stock market’s returns because they’re weighted so heavily in the major indexes. When the AI trade was at its peak when these companies were reporting quarter after quarter of blockbuster earnings, those stocks really pulled the entire market up with them.

But the other side of the coin is that it is just as easy for those names to pull the market down when they struggle and when investors fall out of love with them. And that’s what we’ve been seeing over the past few weeks and on Monday in a more extreme way. And then the second element is that these stocks have been very expensive. They’re trading at a premium to what analysts think they’re intrinsically worth. And some strategists have said that a reset was in order to bring prices back in line with what they’re intrinsically worth. That reset happened yesterday and over the past couple of weeks, and it wasn’t super surprising to analysts who have been looking for it.

Hampton: As we wrap up our conversation, what’s a takeaway or two for investors wondering how they should react to this market volatility?

Hansen: Yesterday was a really great example of why it’s so important for investors to have a long-term plan and to stick with that long-term plan. Volatility like we saw yesterday and selloffs are a normal part of market cycles, and yesterday’s action was not a reason to make any major moves. It was a scary day, but it’s worth remembering that markets are still up more than 8% since January and more than 16% over the past 12 months. And this morning even we’ve already seen Japanese markets start to bounce back and US markets are stabilizing.

Investors who got spooked and sold yesterday put themselves at risk of missing out on future gains. And as we’ve said over and over, and I’m sure you’ve heard before, timing the market is an extremely difficult thing, and it’s kind of a losing game for investors. The one thing our strategists do say, however, is that periods of market volatility like we saw yesterday are a good time to think about rebalancing and making sure that your portfolio allocations are in line with your goals and what you are hoping to achieve with your investments. So, bottom line, stay the course and remember to keep things in perspective. Over the long term, markets go up.

Hampton: Sarah, thank you for those tips. Thank you for reporting on this and telling us what you found out.

Hansen: Thanks for having me. A pleasure.