Highlights
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Headline inflation continues to trend downward.
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The S&P 500 rose for a 5th consecutive month and the Dow had a historic run during July.
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Returns have broadened out as compared to earlier in the year.
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Signs point to the possibility that the Fed may be able to pull off a “soft landing.”
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Economic Update
Inflation continues to moderate. Over the past 12 months, the year-over-year headline Consumer Price Index (CPI) has declined from a peak of 9.0% in June of 2022 to 3.0% in June of 2023. The last time headline CPI was lower was in March of 2021, immediately prior to the rapid rise in inflation. Core CPI, which excludes food and energy prices, rose by 0.16%, its smallest increase since February 2021 and the year-over-year rate fell to 4.8%. Used car prices and airline fares, which have been the more stubborn pockets of inflation both declined year-over-year. Prices for shelter, which is the largest component of CPI rose at a slower rate. While the headline rate of inflation (blue bars in chart below) has steadily declined over the past year, the core measure of inflation (green bars in chart below) has been more stubborn.
Stocks and Bonds
Stocks were up across the board over the past month. With July’s 3.2% return, the S&P 500 rose for the fifth consecutive month in a row, bringing the year-to-date total return to 20.6%. Returns have broadened out over the past two months. From January through May the Equal-Weight S&P 500 Index under-performed the S&P 500, which weights stocks based on their total market value, in four of the five months and by a total of -9.4%. In June and July, the equal-weight index has performed better. According to Howard Silverblatt, Senior Index Analyst with Standard and Poor’s, “A key trading takeaway for the month was the broadening of returns, as breadth declined but remained strong. For June and July, the S&P 500 TR was up 10.03% (6.61% in June and 3.21% in July). The top 10 issues contributed 34.4%. Gone are the days when [7 stocks] accounted for [100% of] the gains (excluding them, the market would have been negative), as it now takes 331 issues to negate the index for the period after May 31, 2023.” The Dow Jones Industrial Average also had a historic run during the month with 13 consecutive up days in a row, a winning streak that has only been matched or exceeded on two other occasions. Performance for the Nasdaq was in the middle of the pack but retains the top spot for 2023.
Mid cap and small cap stocks continued their positive momentum with the Russell 2000 gaining another 6.1% (on top of June’s 8.1%) and the S&P 400 Midcap up 4.1% (after rising 9.2% in June), bringing year-to-date total returns to 14.7% and 13.3%, respectively. Foreign and emerging market stocks were also up, with the MSCI Emerging Markets index the standout for the month (+6.3%).
Similar to June, all 11 sectors of the S&P 500 were positive for the month. Energy was the best sector with a return of 7.4% as oil prices closed 16.1% higher for the month of July. Health Care returned 1.0% for the month and remains in negative territory YTD (-0.5%) along with Utilities (-3.4%). Technology, Communication Services, and Consumer Discretionary continue to stand out as the sector leaders for 2023.
Fixed income returns were relatively muted during the month. Short-term interest rates remained steady while longer-term rates ticked higher. Treasuries were down modestly. Fixed income returns remain in positive territory for the year so far.
Soft Landing?
Over the past 18 months the Fed has been engaged in a battle to fight inflation. During most of the prior calendar year it appeared as if it were very likely that a major recession was an unavoidable side-effect. In the past it has been the rule, not the exception, that the Fed’s actions have led to a recession or some other economic catastrophe in their effort to contain inflation. In fact, as recently as this spring it looked as if the United States was on the brink of another banking crisis with the failure of three of the largest banks in the country.
However, over the past several weeks, the conversation in the financial media has returned to the question of whether the Federal Reserve can achieve a “soft landing” for the U.S. economy. In other words, raising interest rates by an amount that is sufficient to reduce inflation while avoiding a full-on recession. History shows that soft landings have been rare. According to First Trust, the only time the Fed has successfully accomplished this in the past 60 years was between February 1994 and February 1995 when they raised rates from 3% to 6% but the economy continued to expand.
Surprisingly, there are indications that the Fed may be on track to accomplish a similar feat this time. As noted above, inflation has been coming down steadily over the past 12 months and is now running at one-third of its peak. The economy has also been resilient, with second quarter Gross Domestic Product (GDP) growing at 2.4%. Additionally, the S&P 500, after spending most of 2022 in a bear market, has been in an uptrend for the first seven months of 2023 and is now approximately 7% higher than where it stood just prior to the first interest rate hike in March of 2022.
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