Equity Market Correction: How to Position for Turbulence?

Key Points:

• Tesla and Alphabet earnings failed to meet market expectations. While that may have been the trigger for yesterday’s sharp sell-off in the equity markets, stretched investor positioning, yen carry unwinding, and rising political uncertainties also underpinned.
• With more earnings due in the weeks ahead and economic growth starting to deteriorate, markets may continue to be under pressure.
• Diversifying into quality, defensive and non-US equities while adding safe-havens like short-term bonds to a portfolio could potentially help to mitigate risks.

What Happened?

The global equity markets experienced a sharp sell-off yesterday. The S&P 500 and Nasdaq 100 indexes suffered their biggest losses since late 2022.

We have cautioned about valuation risks, especially in Mag 7 companies, as well as concentration risks in several equity updates in the last few weeks.

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Why it Happened?

Several key factors contributed to the market's sharp decline:

Mag 7 Earnings Unable to Justify Stretched Valuations

Two of the Mag 7 companies – Tesla and Alphabet – reported earnings on Tuesday after market-close. Tesla’s margin compression remained a key concern. Alphabet beat analyst expectations, but market was concerned about its high spending on artificial intelligence projects that do not seem to be generating revenues for now. Mag 7 valuations remain under intense scrutiny because of the high growth expectations baked in. Simply meeting analyst estimates is unlikely to be enough. As these companies dominate major indices, their struggles disproportionately impact the broader market.

Stretched Positioning

Investor positioning had become increasingly stretched. Many had piled into risk assets, and the unwinding of these positions added to the selling pressure. High levels of margin debt and leveraged positions exacerbated the market's volatility as investors rushed to liquidate.

Yen Carry Unwinding

The Japanese yen has been experiencing heightened volatility, partly due to yen-funded carry trades unwinding as the Fed is expected to shifting its monetary policy stance. As the yen strengthens, it creates ripple effects in global markets, impacting currency-sensitive investments and increasing uncertainty. We discussed more on the yen carry unwinding in this article.

Political Uncertainty

Rising political uncertainties, including potential changes in US presidential election dynamics and ongoing geopolitical tensions, have added to investor anxiety. This has led to increased volatility as markets react to shifting news and speculation.

How to Position?

Investors can benefit from a strategic approach to navigating the turbulence, and adjust their investment strategy to maintain stability and capitalize on long-term growth. The following are some strategies that can be considered.

Invest in High-Quality Stocks

Focus on investing in high-quality stocks with strong fundamentals. Companies with solid earnings, robust financial health, and a competitive edge are more likely to weather market downturns and provide consistent returns over the long term.

Increase Exposure to Defensive Sectors

Consider boosting your investments in defensive sectors such as utilities, consumer staples, and healthcare. These industries tend to be less sensitive to economic cycles and can offer stability when markets are volatile.

Diversify Beyond the U.S.

Explore diversification by investing outside the U.S. market. Look for value opportunities in the UK and seek growth in emerging markets, particularly in the technology sector. Diversification can help mitigate risk and capture potential growth in undervalued regions.

Allocate Cash to Short-Term Government Bonds and Investment-Grade Debt

Use cash to invest in short-term government bonds and investment-grade corporate debt. These investments can generate yield while providing a safer haven during periods of market uncertainty.

Consider Traditional Safe Havens

Incorporate traditional safe havens into your portfolio, such as gold and high-quality sovereign bonds. Short duration bonds are seemingly safer for now as the longer duration bonds are still prone to volatility due to structural inflation risks.

Look for Bargains

If the market decline extends, keep an eye out for investment bargains. Utilize dollar-cost averaging to take advantage of lower prices and gradually build your position in quality assets.

But most importantly, STAY INVESTED!

Maintaining your investment strategy through market fluctuations is key to long-term success. Staying invested allows you to benefit from the market’s overall growth trajectory and avoids the pitfalls of attempting to time the market. Patience and discipline can be your greatest assets during turbulent times.