July ended with mounting talk of a U.S. recession, but that did little to quell a fresh rally in the stock market. Investors ignored the dire economic data and sent the S&P 500 surging 9.1% in July, for the benchmark index’s best monthly performance in nearly two years.
The announcement of an official recession could take months, and that’s up to the National Bureau of Economic Research (NBER).
In terms of numbers, the Q2 gross domestic product (GDP) flashed in the red, and that marks two consecutive quarters of decline for U.S. growth.
How to account for investors’ seemingly blasé reaction to this dire economic reality? Many are betting the Federal Reserve could soon pivot from its aggressive rate-hiking strategy in reaction to a weaker economy.
It will be several weeks before market participants know if they were overly optimistic or spot-on with their interpretation of Fed Chair Jerome Powell’s comments following the latest FOMC meeting. In the meantime, an earnings season that’s shaping up to be better than expected is also helping to give investors some optimism that, at the very least, the worst of the market’s sell-off is over.
“We are hopeful that we’re going to be emerging from this little bit of a storm we’re going through right now,” says Brian Jacobsen, senior investment strategist at Allspring Global Investments. “Our base case is that we’re finding a bottom in the market, and there’s a high likelihood it was back in June.”
There won’t be another Fed meeting until mid-September, so investors can devote their attention to economic reports and the conclusion of the second-quarter earnings season in what’s historically a pretty average month of returns for the market.
Is the U.S. Economy in Recession?
Following the conclusion of the July Fed meeting, Powell said he doesn’t believe the U.S. is currently in a recession because of the strength of certain precincts of the economy, most importantly the labor market.
Even so, investors and policymakers alike will try to gauge whether those areas of strength can outweigh the areas of weakness.
For Jacobsen, a key takeaway from the meeting was that Fed policymakers must now divide their attention between growth and inflation as they weigh the extent of further interest rate hikes. That emphasizes the always-important-to-watch monthly employment report scheduled for release on Aug. 5.
“We see weakness in some of the data, but it’s not showing up in the jobs data yet,” Jacobsen says. “Are we going to get the hint that job hiring is slowing? That will be a key thing to watch.”
Another key economic report due this month is the consumer price index (CPI), scheduled for release on Aug. 10.
“CPI is probably the single most important report due in August,” says Michael Sheldon, executive director and chief investment officer of RDM Financial Group. “Given that inflation is the most important topic in financial markets, the CPI report will be watched closely.”
The Fed will be able to factor in two more months’ worth of data—for both the employment and CPI reports—before its next policy meeting in September. To get a read on the condition of the economy, investors should also monitor reports like weekly jobless claims, the leading economic indicators and new orders for durable goods, Sheldon says.
“Economic reports that are more timely and give a snapshot of the current outlook for the economy will also be scrutinized throughout the month,” he says, adding that investors are trying to forecast what Fed policy will look like through year-end and heading into 2023.
Jacobsen said it’s unlikely that policymakers will start to tip their hand about the next steps—unless there’s a clear indication that inflation has eased, in which case there might be a “stronger differentiation in opinion,” he says. “For the most part, they’re speaking out of the same hymnal, and some of that is by design.”
Is the Worst of the Bear Market Over?
August begins with the second quarter earnings season at the halfway mark, and it’s shaping up to be the worst quarter for earnings growth since late 2020. Even so, reports from companies, by and large, haven’t been quite as bad as forecast, which has helped lift the stock market from its June low.
Jacobsen says that the current batch of earnings reports is probably a good indicator of what investors can expect in the third and fourth quarters.
And more so than what companies report, they’ll focus on what corporate leaders say about their outlooks for inflation, growth and corporate profit ahead, Sheldon adds.
While the S&P 500 remains in a bear market—a decline of at least 20% from a recent high—some investors are now thinking about positioning for an economic recovery rather than worrying about the potential for a recession that was already priced into stocks, Jacobsen says. Sheldon adds that whether or not the market has indeed hit its bear market low is one that will take time to answer, but the near-term outlook has improved a little bit.
“It’s hard to signal the all-clear yet for the outlook for the market,” Sheldon notes.
At the very least, investors may get a reprieve from the volatility that defined the market through the first half of the year, according to Jacobsen.
“Oftentimes what we see in market rallies is we see volatility drop rather dramatically,” he says, adding that economic reports or comments by Fed Chair Powell could usher in a lower volatility environment. “But the risk is we don’t know the exact timing of when that could happen.”
How to Invest in August
A less chaotic market than the first half of the year should be welcome news, even if it doesn’t necessarily make investing decisions any easier. If the bottom of the bear market was in June, then you “don’t want to miss the market upside,” says Jacobsen.
With so much lingering uncertainty about the economy, Sheldon says his firm’s philosophy is that a balanced approach between growth vs value-oriented strategies is warranted.
And while people don’t typically think about tax-loss harvesting until year-end, he advises that now may be a good time to consider selling some investments at a loss to offset future capital gains.
If you invest in individual stocks, earnings season is a good opportunity to parse out the winners from the losers in terms of those companies that will be able to maintain profit margins—and how they plan to do so, Jacobsen advises.
“That’s where it’s more of an art than a science,” he says. “It’s about listening to what the companies are saying and figuring out if they have credibility and whether you can trust that they can execute.”