Is this the market wake up call we had to have?

There are plenty of leading indicators that investors can use to make intelligent investment decisions, ranging from the Leading Economic Indicators Index (LEI) to the Sahm Rule (which was triggered last Friday) to the Fed Funds Rate/2-year yield correlation which my colleague Carl Capolingua beautifully summated in his wire earlier this week. 

But yesterday, a combination of soft economic data, an unwinding of a huge carry trade (sparked by the Bank of Japan), and a massive spike in options market volatility all created the perfect storm.

Here is just a selection of the many headlines that have been used in the financial press over the last 24-48 hours:

• Dow tumbles 1,000 points, S&P 500 posts worst day since 2022 in global market sell-off (CNBC)
• $6.4 Trillion Stock Wipeout Has Traders Fearing ‘Great Unwind’ Is Just Starting (Bloomberg)
• Is This 1987 All Over Again? What’s Driving the Market Meltdown? (WSJ)
• Why the market's favourite trades are blowing up (AFR - Chanticleer)

So is this a wake up call that investors had to have? We'll try to answer that question in this wire.

Is this the correction investors had to have?

This most recent bout of share market volatility was sparked by the US jobs report on Friday and was fuelled even further by a Japanese Yen-US Dollar carry trade gone wrong. But you cannot say there weren't signs.

As recently as two weeks ago, Ascalon Capital Chief Investment Officer Isaac Poole was stressing the importance of treading carefully in case markets don't get the soft landing they want. In his piece, Poole talked about the importance of paying attention to the ISM Manufacturing PMI. Every time that gauge has fallen below 45, a soft landing has been safely ruled out. Well, last month didn't see a sub-45 reading but markets came very close.

Last month, Coolabah Capital Investments Chief Macro Strategist Kieran Davies discussed the importance of the Sahm Rule. The Sahm Rule argues that a recession has started when the three-month moving average of the US unemployment rate is at least 0.5% higher than its lowest during the previous 12 months. 

While it may sound wonky, this rule has worked in every instance bar one since 1950. Last Friday, it was triggered.

Finally, and this is worth repeating, global share markets have been on a tear. The ASX 200 has achieved several record highs this year, and even as it crossed the psychologically important 8,000 level, a range of sell-side analysts bumped up their year-end price targets but not by much (for instance, Shane Oliver, AMP Chief Economist, only bumped up his ASX year-end target to 8100, and questioned in the same instance whether the rally was sustainable.)

As recently as three weeks ago, the S&P 500 hit another record high - adding to the 30+ record highs it had already seen this year. The S&P 500 fell 3% overnight, which again, is a lot but if you've held since the October 2023 bottom, you'd be up nearly 26%. 

In other words, you don't get this many record highs without experiencing a pullback. Remember how 2021 was followed by 2022? A pullback that, many market commentators have reminded us, is healthy and won't necessitate an emergency rate cut from central banks as a result.

Since 1980, if you bought the S&P 500 after a 5% pullback, you would have generated an average return of 6% over the subsequent 3 months (and positive 84% of the time). 

Even the Japanese stock market, which global investors hadn't given much credence to over the last 30 years, had an incredible run. Until its peak on July 11, the Nikkei 225 had risen 27% year-to-date. Factoring in yesterday's 15% fall and 8% rise at the open this morning (as of writing), you'd be up 20% if you bought a Japanese stock market-tracking ETF in January.

But, at some point, investors also knew the Bank of Japan was going to have to raise interest rates. Inflation is now soaring in a country where deflation was the norm for decades.

The Bank of Japan has only raised rates twice since 2007. Last week's surprise rate rise caught markets on the hop, caused a huge surge in the Yen, and created a massive "liquidation cascade" (as my colleague Kerry Sun put it.)

Warren Buffett: The ultimate leading indicator?

But even if you're not into the macro, paying attention to general investor sentiment (see VIX Index and CNN Fear and Greed Index) can help. Or, you can also watch what the world's best investors are doing. And in this case, the best known of them may have just nailed his timing.

Buffett dumped more than half of his stake in Apple last quarter and appeared not to initiate any large new positions, leaving Berkshire Hathaway with a US$277 billion cash pile. While we can't be sure what specific time Buffett sold his stake last quarter, Apple stock is down 7.6% in the past month alone. Proving, if nothing else, that the Oracle of Omaha has still got it. 

A note of optimism to leave you with

While no one can predict whether this will go from bad to worse, history is on the side of the bulls. Charles Schwab's data reveals there have been 24 market corrections since November 1974, and only five of them became bear markets. 

They are also more common than you think - pullbacks of 10% or more in US share markets occurred 50% of the time between 2002 and 2022. 

So while you may be freaking out right now, you can also choose to think of it as a chance to finally buy some stocks that have been sitting on your watch list for months. It may also be a chance to buy the dip on existing holdings - which is incidentally what J.P. Morgan's trading desk is doing.