CEO House View | Market Sensitivity Is Up, Time to Adjust Your Allocation Strategy

Dear all,

Global markets experienced a volatile month, dipping sharply in early August with a global selloff amid renewed recession fears, followed by a V-shaped rebound in response to rate cut signals from Fed officials. The Dow Jones hit a new high at the end of the month, and markets across Europe and Asia also climbed. Meanwhile, Treasury yields and the dollar, which had remained strong throughout the year, finally retreated amid increased liquidity, while weaker Asian currencies like the yen and the Taiwanese dollar saw notable appreciation. To sum, stocks, bonds, and gold all posted gains for the month, affirming our projection that market gains in Q3 will be driven by a scenario of “moderate economic growth, easing inflation, and increased liquidity.”

Man & Dog Analogy: The Economy is Holding Its Ground

Powell’s statement that “the time has come for policy to adjust” at the Fed’s annual economic symposium in Jackson Hole says everything, confirming the Fed is poised to cut interest rates. Meanwhile, the Deputy Governor of the Bank of Japan, whose surprise tightening move partially fueled the early August market upheaval, also stated that the central bank will refrain from hiking interest rates when the markets are unstable. With these developments, the net proportion of central banks cutting rates has entered positive territory. Since May, with the Fed slowing down its balance sheet reduction and the ECB cutting rates, liquidity has been steadily flowing into the market, in line with our forecast that the final stretch of the bull market will be liquidity-driven. Of course, without decent fundamentals, liquidity alone was unlikely to spur such a straight-up market rebound. The key is that the economy is still resilient enough to provide support.

In my view, two key data points rescued the stock market and triggered the rebound. First, the non-manufacturing PMI (NMI), released on August 5, climbed from 48.8 to 51.4, with key components like business activity (54.5), new orders (52.4), and employment (51.1) all returning above the 50 baseline. Second, released on August 15, U.S. retail sales also hit a new high even when excluding the more volatile auto sales.

Additionally, if we look at the manufacturing sector, although Taiwan’s exports slowed due to typhoon disruptions, new orders have remained strong, with July’s export orders growing by 4.82% year-on-year, exceeding expectations.

To cite the “man and dog” analogy where the stock market is the dog and the economy the man walking the dog, while there’s no clear signs that the man (economic fundamentals) is reversing course, the dog (stock market) has already run far ahead, so naturally it’s coming back to its owner.

Too Early to Call a Recession, But Market Sensitivity Is Rising

A primary driver of the market’s recession fears is the increasing vulnerability of the U.S. labor market, a risk we have been flagging since last month. This vulnerability has indeed been reflected in the latest employment report.

We can analyze the JOLTS data and divide a weakening labor market into three phases: declining job openings > reduced hiring > layoffs. The first two have already begun to show, suggesting some underlying concerns. However, given the absence of a significant uptick in layoffs, it’s still too early to confirm that we’re entering a recession.

• Excess labor demand (2021~2023): Coming out of the pandemic, there wasn’t a shortage of jobs, but a shortage of workers willing to take them. At the time, the focus was on whether the labor force could continue to grow, so as to alleviate excess vacancies. Fortunately, the labor force has increased over the past two years, leading to a steady decline in the job vacancy rate. This was why, despite widespread recession calls over the past two years, we consistently emphasized that such chances were slim.

• Balanced labor supply and demand (current): Now, the job market is pretty balanced. The big question now is whether companies will continue to hire and provide jobs for the growing labor force. Data suggests that the hiring rate and number of hires have not increased, which is a warning sign. This has also caused the U.S. Nonfarm Employment Diffusion Index to hit a 10-year low, indicating fewer industries are adding jobs. Therefore, nonfarm payrolls have become a key indicator to watch closely: we should monitor whether monthly nonfarm payroll gains can recover to the 150,000~200,000 range, ensuring annual nonfarm payroll growth, a key measure of economic momentum, remains at a robust level of 2 million.

• Excess labor supply (not there yet): This is also when the labor market starts to see layoffs. And at least for now, this has not happened. Whether from layoff numbers or components of the unemployed population, we can see that currently rising unemployment is mainly due to frictional factors—coming from reentrants or new entrants to the labor market, rather than from increase in job losers, which would indicate job losses due to layoffs. This suggests it’s too early to conclude that a recession is imminent. That said, we’ll need to closely monitor upcoming data, as market sensitivity to signs of a downturn is rising sharply!

Market Outlook and Allocation Strategy

Overall, as we’ve previously noted, when the economy begins to slow down, the market can still see final rounds of rallies fueled by increased liquidity. Nonetheless, our outlook on the fundamentals has evolved from the all-the-way bullish view we had maintained over the past two years.

This shift aligns with our house view at the beginning of the year: while the first half of the year presented clear wins in equities, the prospects for...

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