BlackRock Identifies Opportunities Amid Global Market Turmoil: Why Recession Fears Are Overblown

The global financial markets are currently experiencing a significant risk-off sentiment. Japan's Topix index has seen a dramatic 20% decline since last Thursday, marking its most substantial three-day downturn in history. While U.S. stocks initially followed suit, they have shown signs of stabilization, trimming earlier losses. Despite prevailing recession fears, we believe these concerns are exaggerated, presenting unique investment opportunities.

The recent spike in recession fears can be traced back to last Friday's U.S. jobs report for July, which revealed an uptick in the unemployment rate to 4.3% from 4.1% and a notable slowdown in job creation. This report exacerbated a global selloff in risk assets that began last month, fueled by apprehensions over tech valuations and escalating geopolitical tensions. Compounding the situation is the stronger yen, which has surged approximately 14% from its 38-year low against the U.S. dollar last month. This yen appreciation has triggered a rapid unwinding of carry trades, where investors borrow low-yielding yen to invest in higher-yielding currencies and assets.

However, we interpret the July U.S. jobs report as indicative of a slowdown rather than an impending recession. The rise in the unemployment rate is primarily driven by an increase in labor supply due to immigration, not layoffs. Although job creation has slowed, it has averaged a healthy 170,000 over the past three months. Consumer spending remains relatively robust despite cooling, and Q2 corporate earnings have surpassed expectations, with S&P 500 earnings growth projected at approximately 13%, compared to the 9% forecasted at the beginning of the earnings season, according to LSEG Datastream data. We anticipate that risk assets will recover as recession fears subside and the rapid unwinding of carry trades stabilizes. Consequently, we maintain our overweight position in U.S. equities, propelled by the AI megatrend, and view the current selloff as a buying opportunity. We believe growth will continue to support risk assets and that the market is overestimating the likelihood of multiple Fed rate cuts.

Japan's Topix index, however, has experienced a more severe decline than during the 2008 global financial crisis. This outsized response suggests that factors beyond U.S. recession fears are influencing Japan's market, with potential global implications if the trend persists. One key factor is the Bank of Japan's (BOJ) recent policy shift, including a rate hike last week, as it seeks to address yen weakness. While the yen's importance in funding global risk assets means a prolonged selloff cannot be ruled out, market sentiment now anticipates the BOJ retracting its hawkish stance. We believe the BOJ will recalibrate its policies, and that technical and sentiment-driven factors are the primary drivers of current market movements, rather than a deterioration in corporate earnings. Therefore, we remain overweight on Japanese stocks on a currency-unhedged basis, noting that they are down only about 8% from their all-time high.

In summary, while the global financial landscape is marked by heightened risk-off sentiment, we see substantial opportunities for discerning investors. The current market conditions, driven by exaggerated recession fears and technical factors, offer potential for recovery and growth in both U.S. and Japanese equities.