Markets Brief: Why Are Investors So Relaxed Amid the Chaos?

Energy Stocks Gain, Utility Stocks Fall

The Morningstar US Market Index ended the week flat, having gained 3.85% over the month of August, and remains priced near our analysts’ assessment of fair value. However, this serene end to the summer masks a wide variation of returns at sector level—US energy stocks gained 2.4% while utilities fell 1.9%, wiping out previous gains during the month. Consumer stocks also fell, with consumer defensive companies down 1.7% faring worse than their consumer cyclical counterparts, which fell 0.6%, despite positive economic news in the form of an increase in second quarter GDP, at an annualized quarterly rate of 3.3%, slightly above the 3.0% initially estimated. The wide variations in stock and sector valuation suggest that the market continues to offer opportunities for selective investors to access attractive returns.

Investors Bank on a September Fed Rate Cut

While July PCE inflation data was in line with estimates, several market commentators expressed concern about the absolute level of inflation in light of the ongoing attacks on the Federal Reserve by President Donald Trump. Investors, in contrast, appeared to be less perturbed, maintaining expectations of a quarter-point cut in September and a further quarter-point by the year-end. Longer term bond yields also remained stable as did the dollar.

Tariffs, Inflation and Why Stocks Can Keep Rising

The sangfroid of investors against the background of continued political uncertainty is surprising, and it would be easy to dismiss this as irrational. It is still important to address the current situation if we are to position our portfolios appropriately.

Here are three scenarios that investors need to assign their own probabilities to:

1. Inflation tends to favor equities as many companies can pass on increases in input prices or use expectations of higher prices to increase margins. This scenario would support companies with strong pricing power but be negative for longer-dated bonds.
2. The President’s policies have been consistently challenged or adjusted following negotiation and so stated policies are likely to be less impactful than originally feared. Support for this view was provided on Friday in a ruling on tariffs by the Court of Appeals for the Federal Circuit. This scenario is consistent with higher volatility, but can be addressed through diversification.
3. Valuations can rise much further from their current levels, boosted by supportive monetary policy and positive investment sentiment. However, these near-term gains typically come at the expense of longer-term losses unless investors remain disciplined in reducing exposure as assets become significantly overvalued.

Each of these scenarios show that the current behavior of investors is reasonable, despite the uncertain economic and geopolitical background. This therefore represents a classic “wall of worry”, over which investors must climb to be successful over the long term.

However, we must remain vigilant and ensure that our portfolios do not become focused on a single scenario, which would undermine our ability to be successful if other scenarios were to prevail.

All Eyes on Friday’s Jobs Data

In a short week, the attention of investors is likely to be focused on the US Employment Report on Friday. Following the sacking of the previous Bureau of Labor Statistics, any weakness in this report will be more difficult for the Trump administration to attribute to political bias and consequently any weakness is likely to lead to stronger calls for more aggressive cuts which could lead to further volatility. You can keep up to date on this and the other releases this week using this calendar.