August Cooldown? Signals From Three Recent Trends

DEWITT, Mich. - Aug. 22, 2023 - PRLog -- Key Takeaways:

• After a steady rally from March through July, the market's mood has shifted more recently, with stocks falling last week, continuing what has been a rather weak August so far. Enthusiasm around a resilient economy, moderating inflation and artificial intelligence is not gone, but it has been countered by global growth concerns and a leg higher in interest rates of late.
• After a string of upside economic data surprises, we think expectations are becoming more realistic. We think the economy will slow, but we don't see a case for a severe downturn, and thus don't view this spate of market weakness as the beginning of a prolonged or deep decline in stock prices.
• Rates have jumped higher recently, which we view more as a reflection of economic growth versus an upcoming round of additional Fed rate hikes. Ten-year interest rates have moved higher than we anticipated, but we don't believe this is the beginning of another phase of rising rates that will fully undermine equity and bond markets.

The heatwave rolling across the country hasn't been matched in the markets, with equities cooling so far in August following the impressive rally from March through July. While no down days are ever fun, we're not surprised or overly concerned that the markets are taking a breather.

The S&P 500 gave back about 2% last week, putting the stock market nearly 5% lower for August¹. Let's not forget, equities had gained 19% from mid-March to the start of this month, so we'll file this under the normal healthy pullback category¹.

Small-caps have given up their lead.

What's changed?

• Small-cap stocks, which are traditionally more sensitive to domestic economic health and trends, outperformed in recent months as economic data surprised to the upside, reflecting a resilient consumer and improving business outlook.  Small-caps (measured by the Russell 2000 Index) gained 14% from May to July amid rising hopes that a recession can be avoided¹.
• Small-caps have given back half of that gain in August, with enthusiasm fading, as data have been more mixed of late.

Momentum in growth and tech has faded.

What's changed?

• The combination of lower interest rates and rising enthusiasm (and even signs of mania) around artificial intelligence provided a strong tailwind to technology and growth stocks for much of this year, pushing year-to-date gains for the Nasdaq near 40% by July¹.
• While the overall market pullback has been modest, the undertone has shifted to being more cautious, with a defensive posture driving a larger dip in these outperforming areas.

Source: 1. FactSet, past performance is not a guarantee of future results.