During the first week of August the markets continued their July decline but started to recover by the second week. The S&P 500 ended the month up over 2% after being down more than 5% at its worst point. Bonds rallied around 1.5% for the month on heightened recession fears, serving as a risk off trade. Value outperformed growth, and foreign stocks outperformed U.S. Stocks. A volatile month for sure as the market recalibrates in advance of the Fed’s anticipated rate cut cycle.
WHAT MOVED THE MARKETS
August started on a continued downtrend as more jobs and inflation data was reported. On August 2nd the labor department reported unemployment spiked to 4.3% — higher than expectations. The market immediately sold off on fears that the Fed, just two days prior, may have missed their chance to cut rates to avert a hard landing. With a rapidly declining labor force, and a sizable uptick in unemployment, fears of recession entered the psyche of market participants. The following week started with large declines in the pre-market as jitters in Japan unwound the yen carry trade. Japan’s stock market dropped more than 10%, and the US markets also dipped around 5% at the open. Things looked like they were deteriorating quickly, and risk assets continued to be sold. However, later in that week, new jobless claims came in much lower than expected, alleviating some of the prior week’s fears that now seemed to be a one off in the tick higher in unemployment. Stocks experienced their worst day on Monday August 6th and their best day, Wednesday August 8th highlighting the increased volatility in the market. In the middle of the month the markets were calm, trending higher, after July’s inflation data was in line with expectations and reached a level below 3% for the first time since 2021. We believe that the prior week’s dramatic slowdown adversely impacting the labor market was overdone, as subsequent data supports an economy that is slowing, not crashing. Additional economic data supported the soft landing/no recession narrative with initial jobless claims coming in lower than expected, and retail sales for July stronger than expected.
PORTFOLIO ADJUSTMENTS
We continued to reduce growth exposure early in the month. After leaning into small caps during July’s small cap surge, we backed off as that trend quickly reversed. We allocated some of the small cap proceeds to mid-caps. As the market bottomed during the second week, and growth once again took the lead after being quite oversold, we took a small position in large growth in the event that this trend persisted. Overall, we ended the month with higher exposure to the S&P 500 than the start of the month, as the S&P 500 had more favorable relative strength characteristics compared to QQQ/growth, exhibiting less volatility in price. We remain overweight value relative to growth. TWG portfolios closed the month with modest gains, but lagging their benchmark as the month was punctuated by several abrupt trend changes. As the market bottomed and moved higher, we performed relatively in line with our benchmark from August 8th to the end of the month. Portfolio composition has changed dramatically since the market peak in July. As daily volatility increases typically so does our trading activity as we attempt to keep up with changing trends. While the summer months were relatively calm with much fewer trades, we are seemingly trading daily more recently as the market attempts to find its footing. We are navigating this volatility pretty well and with a much lower risk profile than how we were positioned during the calmer summer months.
LOOKING AHEAD
The market is going through a recalibration as it digests competing economic concerns. On the one hand, we are on the cusp of a Fed loosening cycle, and it is widely expected that the Fed will start to cut rates in September. On the other hand, economic data continues to point to a slowdown in activity. Unemployment is increasing, fewer jobs are being created, and the consumer is being more cautious and trading down. Another competing viewpoint which is adding to the volatility is how much the Fed will cut rates at their September meeting. If they cut only .25% then some may believe they are not cutting enough to maintain the soft-landing narrative. But if they cut by .50% then some may believe that the Fed is more concerned about a hard landing than they have signaled thus far and perhaps making a policy error or acting too late to stem off a recession. We believe the market will find its footing and exhale a sigh of relief when the Fed starts to cut rates. This is a unique rate cycle, and we believe the Fed is cutting rates because it can, not because it must. The economy is still showing its resilience, but during any regime change there is heightened uncertainty which typically creates a more challenging trading environment. Regardless of the outcome in the near term, we are very well equipped to manage an ever-changing environment and reduce risk and volatility in a systematic way, driven by math and price. We wish you well.
