The old adage of “sell in May and go away” refers to the belief that many investors are better served by setting their positions in the spring and then stepping back from the market during the summer months with the belief that market activity is lower, and you’re better off returning in the fall. I’m not entirely sure that the empirical evidence would completely justify that strategy, but the sentiment that the market really returns to business in the fall is certainly true. Market participants (fund managers, traders, and analysts) vacation in the summer months and come back in the fall ready to go.

Perhaps it has been this dynamic of transitioning into fall that has resulted in greater market volatility and wider swings in performance. What we have witnessed over the past number of weeks has been the market digesting new news and information that a couple of weeks ago appeared to be indicating a worrying slowdown in the economy that might indicate we are moving closer to a recession. Readings on employment combined with concerning corporate reports and elevated valuations in parts of the stock market resulted in a sharp drop in equities and a heightened concern about the health of the economy. Flash forwards a week and the picture has completely flipped: Recent readings on inflation, retail sales, and earnings reports from companies like Walmart would indicate the consumer is still spending and economic trends are positive.

It was noted in last week’s capital market call that the VIX index spiked to an intra-day high of 65.7 on August 5 before closing the day at close to 39. Both of these numbers indicated a significant increase in fear and uncertainty that at this point seems to have abated. Through this week the VIX reading retreated below 20 and is now in the mid-teens. This is relatively low by historical standards and the VIX has averaged close to 20 since 1999.

Over the course of last week, we received several indicators of the strength of the U.S. consumer that were generally positive and served to relieve many of the concerns about the health of the economy. One of the challenges in deciphering the consumer data is how much of the recent trends are signs of a more prolonged period of consumer strain versus more seasonal impacts. It is notable that consumer spending tends to bottom in the August time frame, again as summer vacations wind down but before back-to-school spending really kicks in. There is no doubt the consumer has been faced with inflationary pressures, but how much of that will continue is something that the market will be keenly focused on.

On Wednesday we got the latest inflation reading with the Consumer Price Index (CPI) report showing inflation at 2.9%, which is the lowest level it’s been since March of 2021.¹ However, housing and shelter continue to be a troublesome area with regards to CPI. For the July CPI report, housing and shelter accounted for close to 90% of the increase in the inflation reading. Keep in mind, the way that housing and shelter are included has a significant lag, which leads some optimistic forecasters to the conclusion that we will continue to see overall CPI continue to decline. The shelter component of CPI includes two major items: Rent of primary residence and owners’ equivalent rent (OER). The OER is an estimate of what the owner would be paid if they were renting their home. The OER is the most significant piece as it accounts for 24% to 25% of the CPI. A notable issue with rental income is that it is slow to adjust to current market conditions as most lease agreements of for terms of 12 months. The reading is unlikely to cause the Fed to veer off course in terms of expected rate cuts in September.

The million-dollar question now is if it will be a 25-basis-point cut or 50 basis points. If it’s 50, that could spook the markets as it could indicate the Fed is more concerned about a recession and is forced to act more aggressively. With the recent CPI report, the prediction markets significantly changed the odds in favor of a 25-basis point cut.² During the stress of the prior week (August 5 through 9), interest rate futures implied a roughly 55% chance of 50-basis-point cut and after the latest CPI print, the odds of a 50-basis-point cut dropped to around 25%.

On Thursday we got more good news related to the health of the economy and the consumer in particular. First, Walmart reported strong results and a positive outlook from management regarding what they are seeing in consumer trends.³ Executives noted that they do not see signs of weakening demand and even called out continued demand for more expensive grocery delivery and electronics. On the strength of that report, and perhaps a bit of relief that the results would not be so strong, the stock jumped about 6.6% after the report.

Also on Thursday, the Commerce Department released the latest retail sales report that showed retail sales growing 1% from the prior month, which was better than expectations.⁴ It was noted in the report that much of the gain was from a rebound in spending on vehicles. Tempering enthusiasm was the University of Michigan consumer confidence survey showing little change in consumer confidence from the prior month.⁵ Respondents remained cautious about still-high prices, particularly for lower and lower-middle income households.

Also notable over the past couple of weeks — and really since the end of the prior quarter — has been some change in market leadership. In roughly mid-April there was a resurgence in buying AI related companies as the large hyperscaler’s (companies such as Microsoft, Amazon, Google, and Meta that can build large AI capabilities) announced significant increases in spending on AI initiatives. Fast forward a few months and the market began to question when and how will these very large investments result in profits for investors. As a result, we have seen a pullback in some market leaders such as the Magnificent 7. Perhaps this is a temporary resetting of expectations, and these stocks will return to their market leadership. Or, perhaps, it’s a sign that market participation is broadening out to other areas that have continued to do well but their share prices have lagged. Time will tell, but for the overall health of the market it is usually better to see broader participation from all industries.

What a difference a week can make. Two weeks ago, a rise in unemployment, a sudden drop in the stock market, and warnings from some big companies stoked fears the U.S. was sliding into recession. The results on Thursday mollified those concerns — the stock market is rapidly making back its lost ground with the S&P 500® gaining 1.6% on Thursday alone. 

What to watch this week

On Monday the Conference Board Leading Economic Index will be released with an expectation of a -0.3% reading. This index is designed to provide an early indication of significant turning points in the business cycle and in what direction the economy may be headed in the near term. Last month’s reading of -0.2%, which while down was smaller than the past three months. The prior month reading was fueled by gloomy consumer expectations, weak new orders, negative interest rate spread, and increased number of initial jobless claims. The market will be looking for indications of improvement in the trends of this index.

On Thursday we will get an update on existing home sales, which will be of high interest to the market as a significant data point for the health of the consumer. Mortgage rates have begun to decline from elevated levels, which may help with home sales. Existing home sales are a meaningful indicator of housing activity as existing home sales are about 67% of all home sales. Last month existing home sales of 3.89 million came in below expectations of 4.25 million. Expectations for this month are for 3.8 million units.

On Thursday we will also get further insight into the strength of the employment market with Initial Jobless and Continuing Jobless Claims. Market expectations are for initial claims of 240,000 and continuing jobless claims of 1.88 million. Recent weekly readings of initial jobless claims continue to point to a tight job market, by historical standards. The continuing claims count increased by 6,000 to 1.87 million in the most recent report from July. This is the highest level since November of 2021.

To finish up a busy couple of days on the housing market, we will get the latest report on new home sales. Expectations are for 620,000 new homes sold in the period which is similar to what was reported last month. Last month’s reading was the lowest reading in seven months and well below the forecasted 640,000. The weaker new home sales were attributable to the high home prices and mortgage rates that weighed on buyers’ affordability.

Finally, on Friday, Jerome Powell will provide a commentary on monetary policy easing. Traders and market participants will watch closely for indications. Chairman Powell will be at the Federal Reserve’s Jackson Hole symposium from August 22-24. This is one of the longest standing central bank conferences in the world and brings together economists, financial market participants, and U.S. government representatives to discuss long-term policy issues.