Markets in August

Equities began August with a continuation of the end of July selloff, after the July jobs report showed a significant cooling in employment data. The S&P 500 dropped roughly 8.5% from its July highs as the markets began to worry that the Fed waited too long to lower interest rates, and the economy was beginning to crack. However, the markets began rebounding throughout the rest of the month as additional data showed continued resilience in the economy and U.S. consumer. AI darling NVDA fell 27% from its highs before making up most of the losses by month end.
The S&P 500, developed international index, and emerging market index were up 2.4%, 3.25%, 1.6% respectively. While the small cap index was down 1.5%, after a strong showing in July. Nine of eleven sectors were up, led by the more value centric sectors Consumer Staples, Real Estate, and Health Care up 6%, 5.7%, and 5.1% respectively.
The July jobs report showed 114k jobs added in July, well below the 175k expected. The unemployment rate also rose to 4.3%, which triggered the “Sahm Rule”, rising 0.5% above its 3.8% low. The Sahm Rule has been used an early warning sign of a possible recession.
The weaker than expected jobs report fueled expectations for a 50 bps rate hike at the September FOMC meeting, pushing yields down. This helped the U.S. aggregate bond index have a nice month up 1.4%.

Why It Could Keep Going Higher

The primary driver of U.S. economic growth is the U.S consumer and most Americans are fully employed and enjoyed significant wage gains over the past couple years. Most with low debt service costs.
Inflation continues to decelerate, albeit slowly and the Fed has signaled that they plan to cut rates sometime this year.
Earnings are expected to grow between 8% - 12% in 2024.
Fiscal policy is still providing a tailwind to economic growth.
Artificial Intelligence capex and promises of productivity gains are still in the early stages.
There is a lot of cash on the sidelines and investors may put it to work on the fear of missing out.

Biggest Risk

Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes.
Valuations are stretched and if earnings do not live up to expectations, a sell-off could occur.
Some research reports indicate that excess savings accumulated during the pandemic may have already been depleted and consumer spending is showing signs of cooling.
Credit card debt is reaching an all-time high, delinquency rates are rising on auto loans and credit card balances, and we’re starting to see an increase in bond defaults, albeit all from below average levels.
If the economy does begin to slow down, high wage costs may force employers to lay off workers to maintain profit margins.
Additional bank failures and commercial real estate defaults.
Further Geopolitical tensions.

Economic Data

Q2 GDP was revised higher to 3% vs 1.4% in Q1.
PI fell below 3% and came in at 2.9%. Core CPI came in at 3.2%.
Core PPI fell to 2.4% from 3% last month.
Core PCE is up 2.6% over the year, the same as the previous two months.
The July JOLTS report showed job openings fall further to 7.67M, down from almost 12M.
Retail Sales rose 1% vs. 0.3% expected.
ISM Manufacturing PMI rose slightly to 47.2 but remains in contraction territory.
ISM Services PMI rebounded to 51.4 following a five point drop in June.

What We Are Doing

We are still optimistic that the most important metric for stock market performance, which are corporate earnings, will continue to grow into the next quarter. However, with valuations high, economic data and consumer spending showing signs that they may be weakening, and the U.S. election moving closer, we used some of the recent rally to take a little growth off the table on our more aggressive allocations back in July and added some risk to our more conservative allocations during the selloff in August.

We believe we may continue to see more patches of volatility ahead and we would see any market pull backs as a likely buying opportunity rather than the start of a significant bear market. With inflation moving lower we added to fixed income with the expectations the Fed will begin cutting rates in September.

One of the main areas we are watching closely is if the recent cooling in employment data begins to level off or shows signs of cracking. We will continue to watch the economic dynamic carefully to take advantage of opportunities as they present themselves.

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