July was another positive month for risk assets, with the S&P 500 advancing 3% and NASDAQ 100 (QQQ) gaining 4%. Small caps again took the lead with a 5% advance. Bonds ended the month .07% lower. Funds in our model portfolios participated nicely, with MOAT gaining 4%, SPYV and VTV gaining 3%, in line with the broad market.
Model portfolios slightly lagged their benchmark between .05% and .10% after fees, mostly due to relative weakness in QQQ during the week of 7/17 when they declined 1% vs. the S&P gaining .7%.

WHAT DROVE THE MARKET:
Inflation, GDP and earnings were the main drivers of the market for July. On July 12th, the Consumer Price Index (CPI) was softer than expected, pointing to a continued decline in the year over year inflation data – the lowest in almost two years. This is positive and suggests the Fed is achieving its goal and increasing the odds of a soft landing. Core CPI (which excluded food and energy) fell to 4.8% YOY from 5.3% in June. Headline inflation (includes food and energy) dropped to 3% YOY, significantly lower than it was a year ago when it peaked at 9.1%. Arguably most important is that previous “sticky” components of the core – housing and wage driven services – are finally showing signs of slowing. Housing has also slowed for three straight months, which is welcome and should give the Fed more room to breathe given how large a percentage housing costs are to the average consumer.

On July 26th the Fed raised rates by .25 as expected, and leaving door open for further raises on a “data dependent” basis. Currently, the Fed funds rate stands at 5.5% – a 22-year high.
On July 27, Gross Domestic Product “GDP” for the second quarter came in stronger than expected – 2.4% vs 1.9% consensus. This implies a resilient economy even in the face of the highest Fed funds rate in more than two decades. Recession fears are receding.
Earnings have been supportive of higher stock prices, with 80% of companies’ results reporting a positive earnings per share (EPS) surprise.
Last month we wrote about market expectations. Earnings have been better than expected – not necessarily good, as earnings continue to decline from the prior year – but said decline is not as much as forecasted. This is positive for sentiment and stocks.

PORTFOLIO ADJUSTMENTS:
We have been busy gradually shifting exposure in our model portfolios, mostly by reducing our substantial position in QQQ.(large growth) and increasing exposure to large value.
On July 7th, we trimmed our S&P 500 fund and initiated a position in one of our new funds, SPGP. This is an S&P “growth at a reasonable price” fund that filters the market to identify stocks with growth attributes but less expensive than the broad market. This position enables us to maintain a growth bias, but reduces exposure to the more expensive mega cap tech stocks that have had a nice run this year.
On 7/17 we again trimmed our S&P 500 fund and allocated the proceeds to SPYV (value) and IWP (mid cap growth). We also reduced one of our bond funds – VARBX -which is an “event driven” fund that invests in companies that are in the process of being acquired. We repositioned the proceeds to CWB, a convertible bond fund and FLOT, a floating rate bond fund.
On 7/27 we trimmed 12% of our QQQ position as well as IWP and added to S&P 500 (SPLG) and MOAT.
On 2/28 we further reduced our QQQ position by an additional 10%, reduced IWF (Russell 1000 growth), evacuated IWP (mid growth), and added the proceeds amongst SPLV, SPGP and SPLG. We also initiated a position in NOBL, a fund that invests in the dividend aristocrats – those rare companies that have increased their dividends for at least the past 25 years.
The result was a reduction in exposure to large cap tech, which is showing signs of moderating, and increasing exposure to the value side of the style box. We are excited about these adjustments, as we feel that there is a good chance of value catching up to growth from the latter’s dominance this year. The shifts have been gradual, which is a function of our updated strategy that evaluates over 30 models vs the prior strategy of 5 models.
The updated strategy makes smaller allocation adjustments, which should reduce the instances where abrupt trend changes leave us in the wrong area of the market. Furthermore, varying the sensitivity of the models and increased frequency of model evaluation should enable a more rapid, but gradual, shift to changing trends in the market.

LOOKING AHEAD:
With earnings season winding down, it is challenging to find a catalyst for the market to continue to advance at the pace it has this year. Yes, earnings have broadly come in above expectations, which is supportive of current stock prices. However, as we move through the next 2 months, prior to the next earnings season, we suspect the main drivers of the market will again fall on inflation data.
GDP shows the economy remains resilient, and even saw a rebound in business investment – so it is not just consumers driving the economy. PCE inflation, including core, is falling toward the Fed’s 2% target. And that has helped by slower wage growth, which augurs well for a continued fall in inflation. From here, the Fed will get two more jobs reports and two more CPI reports before its September meeting. If we continue to see solid, but not blowout, jobs numbers and further easing in inflation – especially core – the Fed should be able to hold off on further rate hikes, as markets expect.
The other area we will be keeping our eye on is whether the current earnings season represents a trough in earnings declines. If 3Q earnings show improvement and begin to grow again, then the market has good reason to march up and to the right as earnings troughs typically signal the start of the next phase of economic expansion.
As always, we will continue to follow our trend following process in an effort to capture changes in overall trends and themes. This month we affected a gradual shift from growth to value, and if this trend continues, we could very well be positioned to increase exposure to areas of the market (ie: financials, energy, materials) that have lagged thus far this year.
Enjoy the “dog days” of summer that is August!