As The Market Turns

It came down to the final minute, but the S&P 500 pulled off a stick save to preserve the win and the index posted a positive 1.2% return for the month. This marked the ninth consecutive positive July in a row, the seventh longest monthly streak going back to 1928.

The MSCI All Country World Index performed better, +1.5% on solid Japanese performance, while the TSX was up materially, 5.7%, as both utilities and financials both rose over 7.5%. Bonds continued their performance streak with the iShares Core U.S. Aggregate Bond ETF (AGG) rising 2.2% as the 10-year yield fell from 4.4% to 4.0%.

We first noted sentiment on U.S. bonds becoming overly bearish at month-end in March 2024 (click here). After touching 4.7%, the U.S. 10-year bond yield has fallen below 4%, leading AGG and iShares 20+ Year Treasury Bond ETF (TLT) to gains of approximately 5% and 8.5% over the past three months.

Investors were eagerly anticipating the statement from Federal Reserve Chairman Jerome Powell on 31-Jul-24. While the statement was relatively hawkish, Powell’s press conference that followed allayed any concerns, as he confirmed a September rate cut was on the table.  As economic data continues to tick down, markets were pressing his hand. Accordingly, without pushback from Chairman Power, yields followed through to the downside. There remains to be a lot of wood to chop below on yields, and despite growth slowing, inflation could likely prove more resilient. Time will tell if the gains in bond prices will be durable.

Equity cheerleaders often cite lower rates as a reason to be bullish on the market, ignoring the drivers of those rate reductions. In this instance, the market rose on the back of a stronger-than-expected economy, despite the high interest rate environment. Consequently, it is reasonable that the market can retreat as weaker-than-expected data is released, even while rates are being lowered.

As expected, the U.S. Dollar as measured by DXY, fell 1.7% in July, in response to the Fed’s dovish signaling. Gold was a major beneficiary of the overall macro environment, rising 5.2%. In fact, the yellow metal has now outperformed the mighty S&P 500 on a year-to-date, 1-year, and 3-year basis.

The Bloomberg Commodity Index fell 4.5%. This trend has prevailed since late May 2024, which is largely in response to underwhelming growth in China and now supported by a potential U.S. slowdown.  Energy lead the way down, with crude oil down 5.2% and natural gas down 22.0%. Grains and industrial metals fell more in-line with the index. Similarly, Chinese stocks lagged their global peers, so perhaps this corroborates the weak regional growth and slackening demand for natural resources. Naturally, the fear is that softness in developing Asia seeps into the domestic North American economies.

We highlighted dispersion in our last monthly letter, noting the relentless outperformance of large cap growth as a factor versus small caps, a phenomenon that is not just limited to recent history. Well, while the S&P’s 1.2% gain hinted at a sleepy month for equities, the measures for companies with market values below $2 billion were arousing. The Russell 2000 Index, an index of 2,000 small-cap companies, bounced back aggressively rising 10.4% in July. The majority of these gains accrued since 10-Jul-24, when the S&P 500 fell 4.4% over the same period. In fact, by 09-Jul-24, the year-to-date return for the S&P 500 was 18.8% and it was outperforming the Russell 2000 by 17.6%. Since then that gap has narrowed to 5.4%, as of 31-Jul-24.

Surely, the large cap outperformance was accelerated by institutional money managers who executed a long large cap/short small cap trade. Like anything on Wall Street, the impact on price is exaggerated when all those who are leveraged on one side of the same trade decide to race for the exit. It will be noteworthy to observe whether this is a simple re-balancing or a longer-term trend. Even a limited rotation from the recent winners into small stocks is enormous; considering the Magnificent 7 have a combined market cap that is seven times large than the combined value of all 2,000 companies in the Russell 2000.