Highlights:
July saw a shift in market dynamics, with large tech declining and small and mid-caps rising. The S&P 500 ended the month up 1.2%, while the Russell 2000 jumped 10.2%.
Economic reports and Fed Chairman Powell’s statements supported the expectation of rate cuts due to lower inflation and weak job reports.
The flattening yield curve and expected rate cuts boosted interest rate-sensitive sectors like Real Estate, Utilities, and Financials.
July was a month of twists and turns -- and not just in presidential politics. Within the markets, the byword was rotation as large tech faltered and small and mid cap stocks revived. It took a final day rally to push the S&P 500 Index positive, rising 1.2% for the month, bringing the year-to-date return to a healthy 16.7%. After years of underperformance, small stocks leaped to the head of the class, with the Russell 2000 rising 10.2%, constituting the bulk of the index’s 12.1% year-to-date advance. The fate of the “Magnificent 7” was revealed in the two trailing S&P sectors as Tech fell -2.1% and Communication Services dropped -4.0%. As would be expected given these statistics, large value was well ahead of large growth, a trend that held but was less pronounced in smaller stocks.
While the trends were clear, assigning causality or predicting staying power remains challenging. The bond market offered clues as the long-standing inverted yield curve flattened, particularly in the narrowing 2-year to 10-year spread. Longer yields dropped significantly as the market priced in expectations for Federal Reserve rate cuts, with a 100% probability projection for a quarter point in September and a measurable possibility of a half-point cut. The market was also optimistic regarding November and December cuts. One effect of lower rates is a boost to smaller stocks, which tend to be more leveraged to the cost of borrowing.
Another beneficiary of projected rate cuts tends to be interest rate-sensitive sectors, and these led the S&P 500 in July, with Real Estate up 7.2%, Utilities up 6.8%, and Financials advancing 6.5%. Giving confidence to the projections were economic reports in July and Federal Reserve Chairman Powell’s reiterations in his late July presentation of the Board’s data dependency. The July 11 inflation report showed June consumer prices unexpectedly lower. A shift in demand is being reported by numerous companies, from makers of recreational vehicles to fast-food purveyors. While the economy remained relatively strong, the latest jobs report showed enough signs of weakness to support the projected Fed rate cuts.
One of the most common questions we’re receiving is how the presidential election is likely to affect portfolios. We looked at historic trends, and while the evidence is mixed, there is a tendency for markets to dip as the uncertainty of elections approaches and then rally after the results. This appears to be driven more by uncertainty than by election results in terms of party victories. While presidential policies can impact individual companies and industries, broad economic and geopolitical realities have been more important. Trying to adjust asset allocations based on election projections has been a losing game. One constant has been how a mixed government has been perceived as the best for markets since this reduces the probability of dramatic legislative changes. We prefer to think in longer terms than election cycles and believe that fundamentally sound companies can prosper despite the vagaries of campaign promises and the unavoidable concerns that accompany them.