Markets were higher in July, but the nature of the rise was quite different from recent months. Small and mid-sized US companies led the way as economic data came in that supported less restrictive monetary policy. Large cap US stocks also rose, but only modestly by comparison. Markets outside the US also rose, but emerging market stocks remained a relative laggard.
The reversal in fortune for smaller companies, relative to the largest of the large, was significant and an outlier in magnitude. Whether it is the start of a different market regime, or the unwind of a very crowded trade remains to be seen. We think, as with most market related activity, the causes are complex, and the attribution is open to interpretation. There are some reasons to think it could be the start of a new regime, as capital becomes less costly with lower interest rates and the regulatory regime could become more business friendly. However, an economic contraction or slowdown could delay or prevent a potential regime change.
In fixed income, bond prices saw a rise as interest rates fell and credit spreads remained historically tight. The tightness of spreads is an interesting topic, as they tend to widen out in times of stress. While the economy, on the whole, seems to be in fairly good shape, it is slowing (or normalizing, depending on the prevailing narrative) in certain ways. A growth scare, economic contraction, or crisis could cause spreads to widen. Depending on the narrative or nature of the crisis du joir, that widening could be considerable.
As we write this, there are numerous uncertainties and August is off to a volatile start. From an economic perspective, inflation appears to be cooling along with the labor market. There are reasons to think the inflation outlook is on a better, more sustainable path, as housing inflation finally appears to be decelerating. Whether inflation cools to the Fed’s target, and stays there, is an open question. The labor market seems to be normalizing but there’s a risk it weakens further and leads to a growth scare or recession. Currently, the Fed seems more concerned about the labor market than the inflation outlook and preparing to embark on an easing cycle. While some commentators think the Fed is already behind the curve, that may or may not be true. Our stance is to take them at their word and look for opportunities as they arise.
