Weekly Market Update – July 12, 2024

Quick Takes

• Last week was marked by a rather sudden and sharp trend reversal on Thursday. Large cap and growth stocks have dominated small cap and value stocks for more than a year, but that reversed abruptly last week with big outperformance by small cap and value stocks.
• Global stock and bond indices were higher last week, with the headline S&P 500 Index up +0.9%, the Nasdaq Composite Index up +0.3%, and the small cap Russell 2000 jumping +6.0%, its best week of performance since November 2023. 
• Bonds rallied on softer consumer inflation and dovish comments by Fed chair Jerome Powell. The 10-year U.S. Treasury yield fell -10 basis points, and the 2-year U.S. Treasury yield dropped -15 basis points as U.S. and non-U.S. bonds gained +0.8% and +1.3%, respectively.

Source: Bloomberg. Data as of July 12, 2024.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Was last week’s massive style reversal a blip or trend?

Just after publishing the June Monthly Market Update last week, one of the biggest market trends discussed, the massive outperformance of large cap stocks over small cap stocks, saw a sudden and sharp reversal. For the first half of 2024, ending June 30, the small cap Russell 2000 Index had just a +1.7% total return, while the S&P 500 Index had a first half total return of +15.3%. That was the largest magnitude of underperformance for the first half of a year by the Russell 2000 relative to the S&P 500 since 1998. Then, seemingly out of nowhere, on Thursday, July 11 alone, the Russell 2000 jumped +3.6% while the S&P 500 slipped -0.9%. The Russell’s +4.5% one-day outperformance was the largest single day advantage for the Russell since March 19, 2020 – just days before the market’s pandemic low. With that single-day advantage on Thursday, the Russell outperformed the S&P for the week by +6.0% to +0.9%, respectively. That was the biggest week of outperformance for the Russell since the week ending April 10, 2020. Some market watchers attributed the unusual activity to a rush by hedge funds to deleverage from an over concentration in large cap growth stocks, which had driven the lion’s share of market returns lately. The other notable trend for the week was the reversal between growth and value stocks. Growth stocks have been outperforming value stocks for years, and by historical magnitudes.  The Russell 3000 Value Index outperformed the Russell 3000 Growth Index by +3.1% last week. That was the biggest week of outperformance for value since a +4.1% advantage the week ending April 19th. Before that you have to go back to November 2022 to find a week that value had outperformed growth by more. Before last week growth outperformed value in 10 of the prior 15 weeks. Of course, with growth stocks lagging last week, the Nasdaq Composite Index was only up +0.3%. Non-U.S. equities had a solid week, with developed market international stocks (as measured by the MSCI EAFE Index) climbing +2.3% for the week and the MSCI Emerging Markets Index gaining +1.7%. 

The bulk of those reversals came after two days of testimony (Tuesday and Wednesday) by Federal Reserve chairman Jerome Powell on Capitol Hill in which he hinted at interest rate cuts. Then, on Thursday morning, the June Consumer Price Index (CPI) report showed that the rate of consumer inflation was softer than expected. Markets responded by increasing the probability of a 25-basis-point interest rate cut in September to nearly 90%, up from about 75% at the beginning of the month, according to Fed Funds futures tracked by CME FedWatch.

Bond investors continue to cheer the softer inflation data, and the yield on the 10-year U.S. Treasury note traded down another -10 basis points over the week, following a -12 basis point drop last week. It finished the week with a yield of 4.18%, the lowest level since mid-March. The 2-year U.S. Treasury yield was down even more, falling -15 basis points for the second straight week, to finish at 4.45%, its lowest level since February 7. Bond prices and yields move in opposite directions, and the Bloomberg U.S. Aggregate Bond Index finished the week up +0.8%, while the Bloomberg Global Aggregate ex U.S. Bond Index (non-U.S. bonds) was up +1.3%. A declining U.S. dollar has been a tailwind for non-U.S. bonds and stocks over the last two weeks, after rising in five of the prior six weeks.  

Chart of the Week

The rate of inflation for consumer goods and services declined for the first time in four years. The headline Consumer Price Index (CPI) fell slightly in June at -0.1% compared to the prior month’s unrevised flat reading and below expectations for a +0.1% reading. Year-over-year (YoY) CPI grew at a 3.0% rate, also below expectations for a +3.1% annual rate and down from the prior month’s +3.3% pace. Core CPI, which excludes the more volatile food and energy prices, was up +0.1% for the month, coming in under expectations for +0.2%, which is where it was the prior month. That is the smallest back-to-back increase in more than three years. YoY Core CPI was +3.3%, which was less than the expected +3.4%, which is where it was the prior month. The Federal Reserve and Wall Street generally consider the core rate as a better predictor of future inflation. Both the headline and core measures are now in distinct downtrends and well off their 2022 peak levels.  Details of the report show Shelter and Energy fell for the month. Shelter prices, which is the largest category within services, climbed +0.2%, the smallest gain since August 2021. Owners’ equivalent rent — a subset of shelter, which is the biggest individual component of the CPI — climbed +0.3%, also the slowest pace in three years. As good as the month’s inflation numbers were, many senior Fed officials want confirmation from the Personal Consumption Expenditures (PCE) Index that inflation has slowed enough to justify a reduction in interest rates. The Core PCE Index is the Fed’s preferred inflation gauge and will be released in two weeks. It is also forecasted to show inflation slowing. 

June Consumer Inflation Readings are Lower Than Expected

Consumer Price Index (CPI) Year-over-Year Percentage Change

Source: Source: U.S. Bureau of Labor Statistics, Briefing.com.

Economic Review

• Unlike consumer inflation, wholesale inflation rose more than expected in June. The headline Producer Price Index (PPI) rose +0.2%, above expectations for a +0.1% increase. The prior month was also revised higher to a 0.0% flat reading from the initially reported -0.2% level. The year-over-year (YoY) PPI was hotter than expected, up +2.60% versus Wall Street forecasts for +2.3%. That is up from the prior month’s +2.4% rate, which was itself revised higher from +2.3%. Core PPI, which strips out volatile food and energy costs, was up +0.4%, above an expected +0.2% rise, and up from the prior month’s unrevised +0.3%, which was revised sharply higher from the original 0.0% flat reading. YoY Core PPI was up +3.0%, above expectations for +2.5% and the prior month’s +2.6% annual pace which was revised up from +2.3%. A rise in Services prices was largely responsible for the higher-than-expected wholesale prices, but Goods prices declined. With the year-over-year rates for PPI and Core PPI accelerating for five of the last six months and with rising prices of services outweighing falling prices of goods in June, the Fed may have to place less weight on the prior day’s below expected consumer prices report. PPI tends to take 2-3 months to migrate into CPI, so the Fed may want to wait longer than September to see where CPI goes from here.
• U.S. Consumer Credit rose by $11.354 billion in May, far above expectations for $8.850 billion and the prior month’s $6.485 billion (which was revised slightly higher from $6.403 billion). That’s a +2.7% annual growth rate, up from the +1.5% annualized growth rate the prior month and the highest pace in three months. Growth for revolving credit, such as credit cards, jumped by +6.3% after a -0.8% dip the prior month, which was the first monthly decline since April 2021. Nonrevolving credit, which tends to be much less volatile than revolving credit and includes auto as well as school loans, increased +1.4% following the prior month’s +2.4% rise. The report also showed that borrowing rates on credit cards that charge interest rose to 22.76% in May, just shy of a record in data back to 1994. The data from the Federal Reserve is not adjusted for inflation and does not include mortgage loans, which is the largest category of household debt. Many Americans have exhausted the excess savings they accumulated during the pandemic and are now relying on credit cards and other payment methods to consume. That, combined with the rise in the credit card borrowing rates to near all-time highs cost of living, households are seeing their finances constrained, which may explain a recent pullback in consumer spending. For example, retail sales barely rose in May, and prior months were revised down. 
• The preliminary reading of the July University of Michigan Consumer Sentiment Index fell to an 8-month low of 66.0, down from 68.2 in the final reading from the prior month. That was far short of expectations for 68.5. The Current Economic Conditions component was 64.1, down from last month’s 68.2 and far below the expected 66.0. The Consumer Expectations component fell to 67.2 from 69.6, missing expectations for 69.3. One-year inflation expectations were down to +2.9 from 3.0% the prior month, matching expectations. The five-year inflation expectations also came in at +2.9%, down from last month’s +3.0%, where it was expected to stay.
• The National Federation of Independent Business (NFIB) reported that their Small Business Optimism Index rose to its highest reading of the year in June, to 91.5, up from 90.5 the prior month and above expectations for a 90.2 reading. The bounce wasn’t very robust, though, with just 4 of the 10 components improving, 5 flat, and 1 falling. The biggest increase in the components was from business owners that consider Current Inventory too low, up +6 points from May’s lowest reading since October 1981 to a net -2%. Owners with Plans to Increase Inventories wasn’t far behind with a +4 point increase, also to a net -2%. Firms Expecting the Economy to Improve increased +5 points to -25% after increasing +7 points the prior month. On the other hand, a net 37% of businesses reported Current Job Openings they are Unable to Fill, down -5 points and the only component to fall for the month. Inflation is still the top small business issue, with 21% of owners reporting it as their single most important problem in operating their business, down -1 point from the prior month.  “Main Street remains pessimistic about the economy for the balance of the year,” said NFIB Chief Economist Bill Dunkelberg. “Increasing compensation costs has led to higher prices all around. Meanwhile, no relief from inflation is in sight for small business owners as they prepare for the uncertain months ahead.”
• The Census Bureau reported Wholesale Inventories for May rose +0.6%, up from +0.2% the prior month and in line with expectations. Year-over-Year (YoY) inventories were down -0.5%, the tenth negative YoY reading in a row. Inventories are goods produced for sale that have not been sold yet. Inventories have only added to GDP growth once in the past five quarters. Wholesale Trade Sales were up +0.4%, an improvement from the +0.2% the previous month and above an expected +0.3% rise. Wholesale inventories data isn’t adjusted for inflation. Year-over-Year Wholesale Trade Sales were up +1.9%. The Inventory-to-Sales Ratio was unchanged at 1.35 months. The ratio reflects how long it would take a company to sell all the goods sitting on warehouse shelves. The lower readings vs. last year suggests it’s taking less time for companies to sell their goods. 
• The Treasury Department reported that the U.S. Federal Budget Deficit expanded by $66.0 billion, less than the $76.1 billion shortfall expected. The June shortfall would have been more than twice that size if not for calendar-related quirks in the timing of payments. That brought the fiscal year-to-date shortfall to $1.3 trillion. The government’s fiscal year runs from October through September. Federal Tax Receipts were up +10% from the same period in fiscal year 2023, while Government Outlays were up +5% higher. Year-to-date outlays for interest paid on public debt is up +33% from the same point in the fiscal year last year. This year’s deficit is on track to top last year’s, according to recent projections from the Congressional Budget Office (CBO). The agency estimates that the fiscal 2024 shortfall will be $1.9 trillion, topping the 2023 deficit of $1.7 trillion.
• Weekly MBA Mortgage Applications fell -0.2% for the week ending July 5, following the prior week’s -2.6% drop. The Purchase Index was up +1.0% following a -3.3% drop the prior week. The Refinance Index fell -2.1% following a -1.5% dip the prior week. The average 30-Year Mortgage Rate was right at 7%, down from 7.03% the previous week.
• Weekly Initial Jobless Claims fell -17,000 to 222,000 for the week ending July 6, above expectations for 235,000. The prior week was revised up to 239,000 from 238,0000. The number of people already collecting unemployment claims (i.e., Continuing Claims) rose to 1,852,000 in the week ending June 29, above consensus estimates for 1,860,000. Last week’s reading of 1,858,000 was revised down to 1,856,000.

The Week Ahead

Key economic reports this week will include Retail Sales data for June on Tuesday, which were sluggish in April and May, the latest Federal Reserve Beige Book on Wednesday, and the Conference Board’s Leading Economic Index for June on Thursday. Housing data on Tuesday and Wednesday includes NAHB builder confidence, housing starts and building permits, as well as weekly mortgage applications. Overseas, the European Central Bank will announce their monetary-policy decision on Thursday, though it is widely expected to keep its target interest rate unchanged at 3.75% following a quarter of a percentage point cut in June.

Second-quarter earnings season will also start to pick up this week with some 50 S&P 500 companies scheduled to report profits. Big banks pick up from last week with BlackRock, Goldman Sachs, Bank of America, and Morgan Stanley all set to report. Health care firms UnitedHealth Group and Johnson & Johnson are on the docket. Other companies reporting include Prologis, United Airlines Holdings, D.R. Horton, Domino’s Pizza, Netflix, Taiwan Semiconductor, American Express, Halliburton, and SLB.

Did You Know?

BANK BALANCE SHEETS – Unrealized losses on banks’ balance sheets were $517 billion in May, the Federal Deposit Insurance Corporation (FDIC) said, a level they characterize as having been “unusually high” for nearly 2½ years. Regional banks remain the weak links in the U.S. banking system, while big banks now have more funds on hand to manage a rapid drop in deposits. Commercial real estate (CRE) remains a risk as delinquencies continue to rise. Economists estimate banks hold anywhere from 40% to 50% of all CRE debt outstanding (Source: The Wall Street Journal).

JOB HUNTING – The share of U.S. adults planning to job-hunt in the second half of the year is expected to drop to 35%, down from 49% a year ago, according to a poll by workplace consulting and recruiting firm Robert Half. The April poll also found that 77% were happy with their jobs. The pandemic-era job-hopping fever nicknamed the “great resignation,” has morphed into the “big stay.” Employees looking to quit face a tightening job market and shrinking pay premium for switching jobs, federal data show (Source: Robert Half, The Wall Street Journal). 

CHINESE HACKING – Eight countries, including the U.S., jointly issued a warning about a Chinese state-sponsored hacking group—a rare instance of Western governments uniting in this way. U.S. officials worry that Beijing wants to not only steal sensitive data and weapons information but also target infrastructure underpinning civilian life (Source: The Wall Street Journal).

This Week in History

FROM COFFEE TO STOCKS – On July 12, 1773, Jonathan’s Coffee House in London, where brokers had met for decades to smoke, drink, and trade, was renamed the Stock Exchange (Source: The Wall Street Journal).

Asset Class Performance

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.