Piton July Market Review
The third quarter started with significant momentum. July brought pivotal economic and inflation data, major shifts in equity and bond markets, and a solid consensus on Federal Reserve policy. Additionally, geopolitical risks, including the upcoming presidential election, kept newsrooms busy and America on edge. As July progressed, bond market returns outperformed cash and equity markets. Stock sectors saw a shift away from technology giants, while fixed income markets experienced lower yields and a steeper (less inverted) yield curve.
On a daily basis, the US equity market was driven by earnings reports and the Federal Open Market Committee (FOMC) storyline indicating that an easing posture is set for September held steady. Most equity exchanges remained positive, coupled with a strong economy, benign inflation, and some impressive quarterly performances by large institutions. Significantly lower rates may have prompted a continued shift away from the "magnificent 7" and other technology firms. The Dow Jones Industrial Average led the markets with a total return of 4.51%, while the NASDAQ declined by 0.73% in July. The S&P remained positive at 1.22%, with sector rotations being an important factor for the near future. Contrary to most of 2024, the real estate sector led equity returns in July, up 7.22%, followed by utilities and financials, each increasing over 6%. Only the technology and communication services sectors declined during the month. Notably, small-cap companies saw significant inflows, correlating historically well with real estate, rising over 10%.
Treasury prices initially fell last month as job figures remained strong. However, as data continued to come in and Chairman Powell addressed Congress, yields dropped across the yield curve, bringing bond prices close to levels not seen since the beginning of the year. Some safety buyers emerged throughout the month, partly due to an attempt on former President Trump's life and President Biden's decision to step down from the presidential race, endorsing Vice-President Kamala Harris.
Markets focused on key macroeconomic factors, with benign inflation data, employment data, and Federal Reserve statements driving bond prices higher, particularly in the front end of the yield curve. US 2-year treasury notes fell by 50 basis points to 4.06% in July alone, while 10-year bonds fell by 36 basis points to 4.03%, nearly ending a 2-year inversion. New issue bond auctions saw high demand, and the US Treasury indicated that treasury supply would remain steady in upcoming quarters. The July Fed meeting further supported bond market action, affirming that recent data has increased the Federal Reserve's confidence.
Credit sectors also saw substantial total returns. A strong economy, low inflation, and expected lower rates helped corporate bond spreads remain tight, while benefiting from coupon income and lower rates. Longer-term corporate bonds returned over 3% in July. Other risk sectors also performed well, with the US securitized sector up over 2.5%, including MBS. Investment grade bonds generally outperformed riskier bonds like high yield and emerging markets, as mixed equity returns favored safety. Municipal debt rose approximately 1%, bringing municipal yield ratios versus comparable treasuries closer to fair value. Tax exempt bond returns, which had lagged other investment grade sectors, now have positive total returns for 2024.
Data Recap
Slower data points we have been watching and highlighting in prior monthly commentaries began trending and were certainly captured by markets in July. Last month, anecdotal data and economic releases fell into rhythm. Despite a solid economy, employment seems to be cooling, and consumers are becoming more cautious. Pepsi, for instance, expressed concerns about the future of consumer spending in their quarterly earnings report. Additionally, a large real estate fund needed to cut its dividend. Overall, the earnings season was mixed despite a strong economy.
Monthly nonfarm payroll numbers came in slightly stronger than expectations. Revisions to prior months likely gave the Fed the confidence to mention a robust but cooling employment atmosphere. Service sector jobs fell over the period as well.
Consumer confidence has been declining but stabilized somewhat last month. The monthly retail sales report was a significant positive outlier in last month’s data. However, there were clear signs that lower-income consumers were pulling back amid rising credit card debt.
Second-quarter GDP rose to 2.8% from 1.4% in Q1, indicating that the economy remains on a solid foundation.
Inflation data once again was a key factor in lowering interest rates during the month. The benign data led some economists to suggest that the FOMC should have lowered rates at their July meeting. Some of the more stubborn portions of inflation data, such as rents, showed signs of softening.
Prices paid indices for both manufacturing and services fell again last month.
CPI reported -0.1% growth month-over-month and 3% year-over-year, lower than street estimates. After the CPI report, the bond market priced a 90% probability of a September rate cut.
PPI data rose slightly, but elements suggested PCE data would be favorable.
Core PCE data was stable at 0.2% for June and 2.6% year-over-year.
The Federal Reserve was vocal during July, significantly influencing markets, especially rates. Chairman Powell was careful not to commit to any future actions, but multiple speeches with the same message gave market participants confidence. His testimony to Congress in early July was more dovish, indicating that the "disinflationary path" was back on track. Powell emphasized the Fed’s dual mandate of maximum employment and price stability, explaining that inflation is not the only risk. Employment is equally important to the FOMC now that the 2% inflation target is near. The Fed is focused on "threading the needle" by easing rates before unemployment becomes a problem, yet holding off on lowering rates long enough to ensure inflation does not reaccelerate.
The Fed's statement on July 31st made key points and drove a strong rally in both equity and fixed income markets on the last trading day.
Unemployment has moved up but remains low by historical standards.
The FOMC is waiting for greater confidence in inflation before cutting rates.
The Fed is attentive to risks on both sides of the dual mandate.
Inflation has made further progress in recent months.
The committee's confidence has grown.
While election probabilities shifted, markets remained focused on macroeconomic data and earnings. The U.S. Presidential election represents both a geopolitical risk and a fiscal policy factor for markets, while investors are concerned about the growing deficit. Additionally, Israel issued new attacks near Beirut, and the Ukraine/Russia war continues. Many other central banks are experiencing economic slowdowns and are lowering rates. Amidst all of this activity, Gold was up over 4% in July and over 17% for the year. In this environment, changes can happen quickly. We suggested earlier this year that the upcoming presidential election would impact markets sooner than historical standards. Regardless of summer vacations, markets are taking notice. It is possible that "bad news will begin to be bad news" for markets, and the historical correlation between bond prices and stock prices will resume.
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