Stocks Rally as Risk Demand Rebounds

Photo Credit: Luke Thorton, Unsplash

Weekly Market Recap for August 16th

This week, the S&P 500 continued to trade higher following the recent market volatility. The index has reclaimed its 50-day moving average and improved its technicals from the early August low. This week, the market returned to its 1H 2024 regime. The Magnificent 7 led the equity market higher, with the MAGS ETF gaining nearly +7%. The rally benefited the Growth and Momentum factors, the Technology sector, and the market cap weighted S&P 500. Defensive sectors, the Value factor, and the S&P 500 Equal Weight underperformed due to their underweights to the largest companies. It was a volatile week in the credit market, with yields moving lower early in the week after the CPI and PPI reports showed easing inflation. However, yields reversed higher after Thursday's retail sales report, which signaled underlying consumer strength. Oil ended the week with a gain of over +2%.

S&P 500 Index (Last 12 Months)

S&P 500 Technical Composite (Last 24 Months)

Risk Demand Rebounds After Early August Selloff

Our US Risk Demand Indicator (USRDI) captured the decline in risk sentiment during the selloff. The indicator fell from 0.12 at the end of July to -0.42 in the first week of August, and the decline in risk appetite was evident across multiple categories. In the equity market, cyclical sectors, the Small size, and the High Beta factors underperformed. Equity market volatility increased as the CBOE VIX spiked above 50. In the credit market, corporate investment-grade and high-yield credit spreads widened in the US and Europe. This week, USRDI rebounded to -0.14 as the moves were partially unwound, with the VIX falling to 15, credit spreads tightening, and the Low Volatility factor underperforming. One notable trend to highlight is that all credit inputs, which tend to provide the earliest warning signals, remain risk-on even after declining. While credit spreads have widened, they remain tight by historical standards. Credit's relative calm during the market volatility suggests there is not widespread panic. We will continue to monitor USRDI, but we expect it to trend higher as the extreme volatility fades. If USRDI remains below 0 in the coming weeks, we will view it as a warning sign that risk demand is stalling, which favors more defensive positioning.

US Risk Demand Indicator (Latest Composite Index Reading and Current 6-Month Trend Change)

July Consumer Price Index (CPI) and Producer Price Index (PPI)

CPI
Actual: +0.2%
Consensus: +0.1%
Prior: -0.1%
Commentary: Headline CPI rose by +0.2% after turning negative in June. Core CPI also rose by +0.2%, after it hit the lowest level since August 2021 last month.

PPI
Actual: +0.1%
Consensus: +0.2%
Prior: +0.3%
Commentary: Headline PPI rose by +0.1% after a +0.3% rise in June.

Last month's PPI report was better than it appeared, and this month's report is not as favorable as the headline suggests. The volatile Trade Services category dropped by -1.3% in July after a +1.4% rise in June. Core PPI (ex-Food, Energy, & Trade Services) rose by +0.3%, the highest since April 2024.

The two inflation reports should give the Fed enough confidence to cut rates by -0.25% in September. However, we are concerned about the impact of seasonal adjustments, which made Q1 inflation seem worse and Q2 seem better. Inflation pressures are easing, but investors risk being disappointed later this year as the seasonality tailwinds fade and inflation progress 'stalls', like in fall 2023.

Core CPI

Core PPI

Recent Fedspeak

Multiple Fed officials have spoken since the early August market volatility, and they do not seem overly concerned. Their speeches contrast with a market that believes the Fed is behind the curve. Chicago Fed President Austan Goolsbee referred to the July labor market report as just "one number" and indicated the Fed won't be as reactive as the market thinks. San Francisco Fed President Mary Daly said the labor market is "slowing but not falling off a cliff." Richmond Fed President Thomas Barkin summarized the Fed's dilemma best: "The question is, of course, are we normalizing or are we weakening?" We view the current environment as one of normalization rather than deterioration. When the Fed does start to cut, we expect them to move slowly, unless there a significant shock justifying aggressive cuts.

US Consumer Health Indicator (USCHI)

Look Ahead to Next Week

The big event next week is the Fed's Jackson Hole conference. The Fed has so far been non-committal about its upcoming moves, and there is a chance it could use the annual conference to provide forward guidance.

This week's economic releases included:

Bank Lending Standards
Actual: 7.9%
Prior: 15.6%
Commentary: The lowest percentage of banks tightening lending standards since Q3 2022, shortly after the Fed started hiking; consumer demand for loans weakened, while demand for commercial & industrial loans was unchanged; less tightening signals more robust credit growth, which often leads to economic growth.

Retail Sales
Actual: +1.0%
Consensus: +0.3%
Prior: -0.2%
Commentary: Rebounded after contracting in June due to auto dealer cyberattack; control group, used to calculate GDP, rose by +0.3%, its third consecutive rise; the report suggests the consumer is holding up despite higher rates, softening labor market, and uncertain economic outlook..

Industrial Production
Actual: -0.6%
Consensus: -0.1%
Prior: +0.3%
Commentary: Fed estimates Hurricane Beryl reduced activity by -0.3%; July also weighed down by motor vehicles and parts (-8% m/m); excluding vehicles, manufacturing rose by +0.3% after no change the prior month.

Homebuilder Sentiment
Actual: 39
Consensus: 42
Prior: 41
Commentary: The fourth consecutive monthly decline remains weak despite the recent drop in mortgage rates, as buyers face record home prices; more builders are starting to reduce home prices to attract buyers.

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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