August 2024 Market Commentary

As we reflect on August, the markets certainly gave investors a wild ride. After a strong finish to July, driven by the Federal Reserve's decision to keep interest rates steady, the optimism quickly faded. A series of weaker-than-expected economic reports sparked concerns that the Fed's pause might hint at deeper economic issues, leading to a sharp 8% drop in the S&P 500 in just a few days. Market volatility surged, reaching levels we haven't seen in over a decade.

But just as quickly as markets fell, they rebounded. Positive retail sales data and improving jobless claims reassured investors, pulling stocks and volatility back to where they were at the end of July. This quick recovery was encouraging, but it also highlighted the fragility of investor confidence amid mixed economic signals.

Diving into key data from August, we'll explore what's driving the recent market turbulence and consider what investors should watch as we transition from the summer lull into what could be a pivotal fall for both markets and the economy.

August kicked off with a disappointing jobs report for July. Hiring slowed significantly, with nonfarm payrolls rising by only 114,000, the weakest number since the pandemic recovery. The unemployment rate also ticked up to 4.3%, the highest level in nearly three years. However, this rise wasn't due to widespread layoffs. Instead, it reflected more people re-entering the workforce, pushing the labor-force participation rate slightly higher, to 62.7%. Without this shift, the unemployment rate would have stayed at 4.1%.

Despite the weak jobs data, there were other signs of economic strength. Wages grew by 3.6% year-over-year, outpacing inflation and boosting consumer spending. Corporate earnings also added a layer of reassurance. By the end of August, roughly all companies in the S&P 500 had reported earnings, with a solid 9.8% increase over the prior year and a 4.8% rise in revenues. Notably, 80.7% of those companies beat earnings estimates, showing that businesses are still performing well despite broader recession fears.

The soft jobs data sent global markets into a tailspin, with stock indices from New York to Tokyo feeling the pressure. The S&P 500 posted its steepest decline in two years, and the Nasdaq 100 had its worst start to a month since 2008. Wall Street's volatility index (VIX), known as the "fear gauge," spiked to unseen levels in decades. Japan's Topix index also faced a sharp drop, driven partly by unwinding popular yen carry trades.

Despite the market jitters, hopes for future rate cuts began to rise as traders speculated that the Fed would be forced into easing monetary policy. However, as those hopes for an emergency rate cut faded, uncertainty remained heading into the end of summer.

On the inflation front, July's data showed that price pressures are continuing to ease. The core Consumer Price Index (CPI), which excludes food and energy, rose 3.2% year-over-year, the slowest pace since early 2021. Every month, core CPI increased by just 0.2%, largely driven by shelter costs. Overall, inflation trends align with the Federal Reserve's goal of taming price increases, strengthening the case for a modest 25-basis-point rate cut in the coming months.

Consumer spending, which remains a key driver of economic growth, rose by 0.4% in July (adjusted for inflation), suggesting that households are still spending, particularly on big-ticket items like vehicles. However, there are growing concerns about the sustainability of this strength. Income growth has been sluggish, and the savings rate dropped to 2.9%, its second-lowest level since 2008, signaling that future spending could be at risk.

As we move into the fall, investors should be mindful of potential economic shifts that could impact markets. Federal Reserve Chair Jerome Powell's speech at the Jackson Hole symposium confirmed that the Fed is nearing a critical turning point in its monetary policy. While inflation has moderated, Powell emphasized that future rate cuts will depend heavily on how economic data evolves, particularly in the labor market.

However, investors must be cautious, as several warning signs suggest that the U.S. economy could still be at risk of a slowdown. The Conference Board's Leading Economic Index® (LEI) fell by 0.6% in July, marking its 16th consecutive month of decline. This brings the LEI to 100.4, with a cumulative drop of 2.1% over the last six months—although this decline is slower than earlier in the year, it still signals economic contraction. The index reflects broad-based weaknesses, including reduced manufacturing hours, declining new orders, and weak consumer expectations. These trends indicate continued headwinds, reinforcing the possibility of a mild recession later this year or early next.

While some positive economic data, like resilient consumer spending, may temporarily ease fears, the LEI's persistent contraction suggests that underlying risks remain. The ongoing yield curve inversion, a key recession indicator, and the softening in building permits and labor market data further support the need for caution. With U.S. GDP growth expected to slow to just 0.6% in Q3 and 1% in Q4, investors should brace for a potentially weaker economic environment.

The upcoming inflation reports and job data leading into the Federal Open Market Committee (FOMC) meeting in September will clarify the Fed's trajectory more. A 25-basis-point rate cut is widely anticipated, but questions remain about the pace and magnitude of future cuts.

Investors should reexamine their portfolios heading into what could be a crucial period for the economy and markets. The excitement around artificial intelligence (AI) has driven major investments in tech, but this concentrated trade carries risks. Companies like Alphabet, Microsoft, and Nvidia have poured billions into AI infrastructure, but supply chain bottlenecks and questions around profitability could pose challenges.

At the same time, the broader U.S. economy is showing signs of strain. Consumer spending, wage growth, and housing are all cooling, and manufacturing activity is slowing. If the economy continues to weaken, we could see a U.S. recession on the horizon. While hopes are high for Federal Reserve rate cuts, history shows that markets can still face headwinds even as rates decline. Investors should be cautious about overly aggressive risk exposure and consider diversifying sooner rather than later.