Market Commentary: Stocks Take a Breather

Stocks Take a Breather

After a huge run-up in June, stocks have consolidated in July, which is perfectly normal. We continue to hear predictions of a stock market fall and economic recession, but we disagree with both assessments. Two data points indicate continued strength. The S&P 500 has not broken the August 2022 peak, and consumer discretionary is outperforming consumer staples. The latter is a sign of a healthy bull market, as it suggests a risk-on appetite. As long as discretionary stocks outperform staples and the S&P 500 remains above the August 2022 peak, the surprise summer rally likely has legs.

  • Stocks consolidate gains after a historic six-month run.
  • Stocks will likely rise over the next six months, but the late summer months can be weak.
  • The big picture is the economy is normalizing.
  • Employment remains strong, driving healthy incomes and consumption.
  • Headwinds from 2022 are fading, and that’s positive for future returns.

As we noted last week, June 2023 marked the second-best six-month start for the S&P 500 this century, beaten only by 2019. But just because stocks were up significantly during the first six months of the year doesn’t mean weakness will follow. In fact, stocks typically outperform the rest of the year when the first six months are strong. We think new all-time highs are possible for stocks in 2023. However, we want to be clear: August, September, and October have not historically been great months for stocks. We remain overweight stocks and expect higher prices before the end of 2023, but some type of seasonal weakness over the coming months would be perfectly normal. As President Dwight D. Eisenhower said, “Plans are useless, but planning is everything.” Make a plan now should stocks see some weakness this fall, as it could be an opportunity to add to exposure.

Big Picture: The Economy Is Normalizing

We started this year discussing how the economy has been at the “edge of normal” in our 2023 outlook. The good news is we have slowly but surely moved toward normal since then, even in the face of a banking crisis and debt ceiling drama. The “soft” economic data from sentiment surveys have been poor, but the “hard” data that measure actual employment, sales, and production, have painted a much brighter picture.

We discussed last month how we combine much of the economic data into our own proprietary leading economic index (LEI), which we produce for 30 countries around the world, each one custom built to capture the dynamics of those economies. The individual country LEIs are subsequently rolled up into a global index to give us a picture of the global economy. The idea is to provide an early warning signal about economic turning points. Simply put, it tells us what the economy is doing today and what it is likely to do soon.

For example, our index for the U.S. includes 20+ components, including consumer-related indicators, which make up 50% of the index, housing activity, business and manufacturing activity, as well as sentiment and financial markets data. This contrasts with other popular LEIs, which are premised on the fact that the manufacturing sector and business activity/sentiment are leading indicators of the economy. This worked well in the past but is probably not indicative of what’s happening in the economy right now.

Currently, our LEI suggests the U.S. economy is growing along trend, or slightly above it. The economic picture looks even better than it did at the end of 2023. Six months ago, the risk of recession was higher, but even then the LEI didn’t signal that we were in a recession or even very close to one.

However, we’re seeing some interesting dynamics under the hood.

2022 Headwinds Are Fading

As mentioned above, our LEI has consistently indicated that the U.S. economy is not in a recession. That was almost entirely thanks to resilient consumers, with strong employment gains powering incomes and consumption. Pushing against this was an aggressive Federal Reserve and tighter financial conditions. Consequently, the sector that took the biggest hit last year was housing, followed by a slowdown in business spending and manufacturing activity.

But a turnaround is happening now.

As the chart below shows, the LEI has rebounded over the last few months. That’s on the back of declining headwinds from housing (yellow), business/manufacturing activity (green), and financial conditions.

In fact, housing has moved to being a positive contributor! We’ve written about why we believe housing will no longer be a drag on the economy after eight straight quarters of pulling GDP growth down. Even business activity is exerting a lesser drag on the economy. Just last week we wrote about how investment has been rising recently, hopefully signaling a bottom.

Financial conditions are also easing, especially with the Fed moderating the pace of rate hikes and interest rates inching close to their terminal level for the cycle.

Most importantly, consumption remains positive. But it has declined from a few months ago. This is not really a concern, at least not yet, as it simply indicates that consumption trends are normalizing. The latest contribution from consumption to our LEI is equivalent to its pre-pandemic contributions.

The June payroll report was solid once again. Payrolls grew 209,000 in June; monthly payroll growth has averaged 244,000 over the past three months. So far this year, the economy has created 1.67 million jobs. The unemployment rate dipped down to 3.6%, which is not far from 50+ year lows. In short, the labor market is healthy and that’s keeping incomes strong, which is positive for consumption going forward.

Our conclusion from all this data is the economy is finally normalizing after a few years of being whipped around by the pandemic and its after-effects.


This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.

A diversified portfolio does not assure a profit or protect against loss in a declining market.

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