In July, tech stocks that had driven market gains in the first half of the year stumbled, while small-caps surged on rising expectations for interest rate cuts. Only two of the S&P 500’s eleven sectors declined: Communication Services and Information Technology. The market was led by Real Estate and Financials. Expectations for rate cuts also buoyed industries hardest hit by the Fed’s hikes, with regional bank and homebuilder stocks surging.
For the past few months, soft economic data suggesting lower inflation and potential rate cuts has been welcomed. The Fed hinted at a September rate cut, but recent weak signals from jobless claims and manufacturing have raised investor concerns about the Fed potentially pushing the economy into weakness before it can act again in over six weeks. Sentiment is clearly moving the market direction.
The market started declining in mid-July as the Magnificent Seven stocks fell, and a rotation from tech to small and mid-caps occurred. The Russell 2000 (RUT) eventually broke out of its nearly two-year consolidation channel. Most investors expected the rally to continue as breadth rotation finally kicked in. A bullish Whaley breadth thrust was triggered by the end of July. However, market sentiment quickly shifted from contented to concerned. Investors feared the Fed might overshoot its goal, pushing the economy into weakness before it could act again in over six weeks.
Things turned ugly when the SPX broke its nine-month uptrend with a gap down and increasing volume in the first two days of August. This was followed by disappointing earnings from several key companies. The SPX needs to reclaim its 50-day moving average (5449) and fill the gap quickly to gauge the strength of either direction. The next two support levels could be 5302 and 5191, where we hope the market will stabilize.
In July, our long-term investment portfolio experienced a minor setback, with a return of -0.86%, bringing the cumulative gain since May 2020 to 151.64%. Our dynamic investment portfolio gained 2.59%, leading to an overall return of 78.43% since May 2020. (For detailed insights, please refer to our latest performance report). Our structured note portfolio has averaged a 14.74% return for all closed notes by July, reflecting the necessity of protections during volatile market conditions.
The rotation is not completely dead yet. Although small and mid-cap, financial, and utilities sectors are currently under pressure, the growing fear of a recession significantly impacts market movement. The Sahm rule (named after FED economist Claudia Sahm, which suggests a recession is likely if the unemployment rate (3-month avg) rises by 0.5% from its low) has been triggered. Is this time exceptional, as the rule had two false positives (1959, 1969)? Is the market overreacting? Soon we will find out from this correction!