🔍 The focus this week: Not too hot, not too cold

Most of the time, markets are calm, rational, and efficient, moved by stuff like economic strength, inflation, and interest rates. But last week’s drama flipped the script, proving that you can’t ignore narratives, sentiment, and technicals.

See, right now, investors are jittery, worried that the bull market’s two biggest assumptions might shatter. They see the AI hype dying down and the US job market weakening – and that’s testing their faith that the economy can continue its gentle recession-free glide. They’re sick of waiting for the Federal Reserve (Fed) to lower interest rates and are shouting for a 0.5 percentage point slash at next month’s meeting – if not before – roughly double the usual trim.

Lord knows what investors will be like if next week’s inflation update is off by a beat. They’re holding out for a "just right" figure to calm the market’s jangly nerves. If the number’s too hot, it’ll make it hard for the Fed to lower interest rates now: higher rates are its best tool for cooling consumer price rises. But if the number’s too cold, it could hint that we’re headed to a place where no one wants to go – recession. Either outcome could add fuel to the sell-off fire.

Still, there’s a glimmer of hope about this data. Inflationary pressures have been easing, particularly across the more stubborn components. And though the year-over-year comparisons might not look as encouraging – prices were already on the decline from their peak last year – there are signs that prices have been steadily dropping over the past three months. That should bring inflation a good step closer to its target, and allow the Fed to start chipping away at interest rates.

Whatever happens with the data, and whatever the market’s response to it, remember to take a breather rather than getting swept up in the erratic, fleeting movements. It’s just one piece of data, after all. So stick to your well-thought-out strategy, ideally one that features a diversified portfolio. Panic is not a plan.

📅 On the calendar

• Monday: Earnings: Barrick Gold.
• Tuesday: UK unemployment (June), German economic sentiment (August), US PPI (July). Earnings: Home Depot.
• Wednesday: US inflation (June). Earnings: Cisco.
• Thursday: UK and Japan GDP (Q2), US retail sales (July), China retail sales and industrial production (July). Earnings: Walmart, Applied Materials, JD.com, Deere.
• Friday: UK retail sales (July), US consumer sentiment (August).

👀 What you might’ve missed last week

Global

• Global markets saw some spectacular sell-offs, and the stock market’s fear gauge spiked to levels reminiscent of past crises.

US

• Tech stocks remained under pressure, with AI poster child Nvidia falling 30% from its peak.
• A weekly update from the job market eased worries just a tad.

Japan

• The Bank of Japan appeared to be bowing to market pressure, suggesting it wouldn’t hike interest rates again until the turbulence settles.

✍️ What does all this mean?

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, sure, 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 Labor 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 normalcy, while 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 epicenter 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 stabilize. Hearing the BoJ yield to market pressures might’ve 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.