
Market dynamics are shifting as monetary, fiscal, and political factors come into play, prompting a notable rotation from leaders to laggards. Whether this marks an inflection point or a temporary shift remains to be seen, but investors have been encouraged by a material broadening in the equity market. The driving force behind the rotation has been a hyper focus on slowing inflation and the knock-on effects of an expected policy easing at the Federal Reserve’s September meeting.
While retail sales showed resilience this week, other indicators from the labor market, trade data, and domestic activity suggest a moderating economic backdrop that supports a near-term rate cut. FOMC voting members have been noting the deterioration in the data and are eager to avoid keeping rates too high for too long, which could stifle economic momentum. Several Fed Governors have been laying the groundwork for easing financial conditions and market participants expect Chair Powell to address this at the July 30-31 meeting.
It was a generally risk-off week, with all major US indices trading in the red. Given the orderly drawdown, market volatility has been largely muted. The S&P 500 Index has not posted a 2% down day in over 350 trading days, speaking to the extended risk-on rally. For the week, the S&P 500 Index decreased 2.0%, while small caps as measured by the Russell 2000 Index rose 1.7%. In fixed income, the US Aggregate Bond Index fell 0.3%.
S&P 500 Index Heads for Longest Streak Without 2% Decline Since 2007
Consecutive trading days without 2% decline
Source: Bloomberg
While the market posted the worst week since April, there are some notable undercurrents. Up until Thursday, there were six straight trading days of rotation from large caps into small, and more broadly, growth into value. In other words, investors rotated out of market leaders and into relative laggards with the performance gap between these factors the widest since November 2020, when a COVID vaccine was announced.
There are some important monetary and fiscal reasons for the cyclical rotation—namely, small-caps carry greater floating rate debt, so expectations of lower rates are helpful. Politically, a Trump administration would likely stand for deregulation and fiscal expansion, both tailwinds for smaller companies. The rotation pushed market volatility higher with the CBOE Volatility Index (VIX), often referred to as the market’s fear gauge, reaching levels last seen in late April. With economic data moderating and markets entering a period of greater uncertainty, investors should prepare for more volatility in the second half of 2024.
On the consumer front, retail sales (excluding autos) increased 0.4% in June according to the US Census Bureau, rising by the most in three months in a sign that consumers are regaining confidence in the summer months. The rise in June is accompanied by a 0.2% upward revision for May. Total retail sales were unchanged in June, held back by a 2% slide in autos. But the control group, an important input to GDP calculations that excludes food, autos, building materials and gas, increased 0.9%, matching the largest increase since April 2023. Recent retail data reverses months showing a gradual slowdown suggesting the consumer is still holding up.
US Retail Sales Surprise in June
Source: US Census Bureau, Bloomberg.
Finally, it’s worth noting that Continuing Jobless Claims trend higher and have been increasing steadily over the past nine weeks as layoff from large companies impact the workforce. New applications for unemployment benefits also rose last week by the most since early May, adding to evidence of a softening labor market. Several Federal Reserve members have been highlighting the claims data in recent speaking engagements as a risk to the economic outlook and a data point supporting policy easing. There is a lot of data set to be released before a potential first rate cut in September, but the rhetoric is clearly being picked up by investors.
US Initial Jobless Claims Rise More Than Expected
Initial vs Continue Jobless Claims
Source: US Department of Labor, Bloomberg.
– Written by Eric Schmitz, CFA