August had a turbulent start but ended on a positive note for markets. Early in the month, softer U.S. jobs data and the unwinding of carry trades led to a sharp sell-off in global equity markets. In contrast, global bonds rallied as markets began pricing in higher rate cut expectations. However, global equities quickly recovered as rate cut expectations increased and ended August up 2.6%. Some brighter U.S. economic data also helped to calm recession fears. Despite increased volatility and related headlines, the outlook for the global economy and markets remains largely unchanged.

The primary focus in August was the U.S. labor market. The jobs report showed fewer jobs added than expected (+114K), and the unemployment rate rose to 4.3%. In the following weeks, more stable initial jobless claims data helped to calm fears, and the U.S. economy still seems to be normalizing rather than deteriorating. The jobs report triggered strong market reactions, particularly in the U.S. and Japan. In Japan, the sell-off was also exacerbated by the unwinding of carry trades, a popular strategy involving borrowing in a low-cost currency to fund higher-yielding investments. Currently, it is estimated that most carry trades have now been unwound, and the fundamental investment case for Japan has not changed. Japanese equity markets also rebounded, ending the month up +0.5%, with lower valuations providing an attractive entry point for investors.

Attention is turning to upcoming rate cuts by developed market central banks and their implications for markets. The past two months have underscored how quickly conditions can change: global bond yields have fallen by 42bps, highlighting the need to step out of cash and extend duration. Global core bond performance was a solid 2.4% in August and could improve further in a falling rate environment. Markets are pricing in 100bps of cuts this year in the U.S. Meanwhile, cuts in Europe are expected to be more gradual. With the Fed's September meeting quickly approaching, the opportunity cost of holding too much cash is growing. During the last six rate cutting cycles, bonds outperformed cash in the following 12 months, and stocks outperformed in the absence of a recession. Therefore, it is time for investors to consider extending duration within core fixed income to lock in higher yields.

Within equities, U.S. large and mid-cap quality companies continue to look the most attractive across both Growth and Value sectors. U.S. earnings growth is expected to continue broadening out beyond the Magnificent 7, but investors should still be mindful of concentration risk with early AI winners. Investors should also consider adding exposure to interesting global themes, such as corporate governance reforms in Japan and the tech rebound in EM ex-China.

For additional yield and diversification, investors should consider alternatives, such as private equity and infrastructure. Over the past decade, private equity has outperformed the 60/40 portfolio by 5.9%, and sectors like transport provided 4.5% more income. In times of high rate volatility and unstable stock/bond correlations, alternatives can significantly enhance traditional portfolios.

Upcoming rate cuts and uneven markets highlight the need for thoughtful asset allocation and risk management. It’s crucial to avoid reacting to dramatic market swings and to stick to one’s investment plan. Opportunities in fixed income (upcoming Fed rate cuts), global equities (broadening out of performance in the U.S. and structural trends in Japan and EM ex-China), and alternatives (help to increase overall portfolio yield and diversification) emphasize the value of diversifying into interesting sectors and regions.