Market Rotation, Fed Decisions Shape Volatile Month | Opinion

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July brought a cool breeze to the red-hot rally that defined the first half of 2024. The S&P 500’s modest 1% gain that month contrasted sharply with its blistering 14.5% gain in the first six months, when it set about three dozen record highs. Much of that slowdown was due to a rotation out of large-cap stocks and into small-cap stocks, which eroded the market’s earlier momentum.

The Dow Jones Industrial Average outpaced its peers with a 4 percent gain, while the tech-heavy Nasdaq Composite fell slightly. The divergence underscored a key theme of the month: the shift from AI-powered tech giants to lagging sectors like industrials and smaller companies.

The Federal Reserve’s actions have played a key role in shaping market sentiment. While the decision to keep interest rates unchanged at its July 31 meeting was widely expected, investors were closely watching Federal Reserve Chairman Jerome Powell’s press conference for clues about future policy. Encouraging inflation data, combined with a cooling but resilient labor market, have fueled expectations of potential rate cuts as early as September. The PCE price index rose 2.5 percent year over year in June, approaching the Fed’s 2 percent target, bolstering hopes for a “soft landing” scenario.

Markets reacted sharply in the days following the Fed’s July meeting. The Dow Jones Industrial Average fell more than 600 points in a single day, reflecting investor disappointment that the Fed had not moved more decisively toward rate cuts. That negative sentiment was compounded by a weaker-than-expected employment report on Aug. 2, showing only 114,000 new jobs added in July and unemployment rising to 4.3 percent. While that data supported the case for future rate cuts, it also fueled concerns about a potential economic slowdown.

The market’s wild reaction underscored the delicate balance the Fed must strike. While lower rates can spur growth, premature cuts risk reigniting inflation. Stock traders who had priced in rate cuts were forced to recalibrate their expectations, leading to a sharp sell-off.

Labor market data in early July suggested a gradual normalization. The JOLTS (Job Openings and Labor Turnover Summary) report showed that the number of job openings in June remained at 8.2 million and the unemployment rate was 4.1 percent, supporting hopes for a “soft landing.”

The expectation of rate cuts has prompted a significant market rotation. The Russell 2000 small-cap index is up 11 percent since the beginning of the year, outperforming the Nasdaq Composite by 12.8 percentage points in July — its biggest monthly gain since February 2001. That rotation has come at the expense of large-cap technology stocks. Microsoft, Apple and Nvidia have faced increased scrutiny and profit-taking, with Nvidia shares falling 7 percent in a single day.

Despite this volatility, large-cap companies across all sectors remain fundamentally strong, with solid balance sheets and positive cash flows. The market reaction reflects changing economic expectations, not a change in the long-term prospects of these companies.

Not all sectors benefited equally from the rotation. Consumer staples, typically a haven during volatility, unexpectedly underperformed other defensive sectors. Nestlé and Kimberly-Clark posted mixed results, underscoring concerns about changing U.S. consumer behavior and increased promotional activity, particularly among lower-income demographics.

July also highlighted the market’s vulnerability to technology disruptions. A significant bug in CrowdStrike’s cybersecurity software caused widespread outages, affecting millions of Microsoft Windows devices worldwide and disrupting operations worldwide. The incident led to a sharp 11 percent drop in CrowdStrike’s stock price and rippled through the technology sector, reminding us of the interconnectedness of the world and the potential for local technology issues to have far-reaching market effects.

Looking ahead, investors should not be overly reactive to day-to-day trading activity. The lessons of history remind us of the importance of maintaining a diversified, long-term approach to investing. While recent market volatility may seem unsettling, it’s important to see the forest through the trees. Just as investors may have overreacted to the AI ​​hype earlier in the year, there’s a risk of being overly pessimistic during a market pullback.

The U.S. economy has shown resilience, with GDP growing at an annual rate of 2.4 percent in the second quarter. Consumer confidence, although slightly lower, remains strong at 117.0 in July. These economic forces, combined with potential changes in Fed policy, should provide support for stocks in the coming months.

July 2024 reminded us that markets are multi-faceted. While the headline numbers suggested a quiet month, significant rotations were taking place beneath the surface. Going forward, maintaining conviction in high-quality companies across sectors will be key to navigating market volatility.

William Rutherford is the founder and portfolio manager of Rutherford Investment Management, based in Portland. Contact him at 888-755-6546 or (email protected). The information contained herein is obtained from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. Investment involves risk and may result in loss.

The opinions, beliefs, and points of view expressed in the preceding commentary are those of the author and do not necessarily reflect the opinions, beliefs, and points of view of the Daily Journal of Commerce or its editors. Neither the author nor DJC guarantee the accuracy or completeness of any information published herein.