August's market volatility, driven by tech stock concerns and economic uncertainty, has investors bracing for rate cuts and geopolitical risks ahead of election season.
During the scorching heat of summer, both stocks and bonds experienced a noticeable chill in returns.
July granted gains, but August swiftly reclaimed them. The S&P 500 stock index closed the month with a 1.59% decline, mirroring the 0.64% drop in the Bloomberg US Agg Bond index. While market pundits had predicted this pullback after July’s rally, it became somewhat of a self-fulfilling prophecy. However, the primary driver of this underperformance was the prevailing outlook on future interest rates, primarily influenced by inflation.
Short-term bonds and money market funds continued to offer attractive alternatives to stocks, with rates ranging from 5% to 5.25%. More significantly, August witnessed a surge in long-term rates. The interest rate on 10-year Treasury bonds steadily climbed throughout the month, reaching a peak of 4.34% on August 22 before settling at 4.09% by month-end. This rate increase was spurred by a significant volume of government bond sales, which typically pushes rates up and prices down.
The evolving narrative about the economy enticed some potential bond investors back into the stock market as it fluctuated throughout the month. It’s no coincidence that the S&P 500 hit its monthly low on August 21, nearly coinciding with the peak in 10-year interest rates. The stock market rebounded as rates subsided for the remainder of the month. The economic outlook shifted towards one of strength, with the possibility of avoiding a recession coming into view—a significant change from the past few months.
The two-month trend of small-cap stocks outperforming large-cap stocks reversed, with the Russell 2000 stock index dropping 5% for the month. Companies like Eli Lilly, Nvidia, Google, and Amazon continued their impressive performances, bolstering returns for larger company stocks compared to their smaller counterparts. The small-cap index has a more significant allocation to financial (including banking and insurance) and real estate sectors compared to the S&P 500, and both sectors continued to face challenges.
Banks grappled with the dilemma of offering higher deposit rates to customers while having limited capacity or desire to lend, thanks to the Federal Reserve’s efforts to slow the economy. Additionally, credit downgrades, potential downgrades, and negative outlooks from ratings agencies like Moody’s and Fitch weighed on the sector’s performance in August.
Insurance companies faced ongoing losses from natural disasters like storms, fires, and floods, which negatively impacted their businesses. Some major markets, such as California and Florida, witnessed insurers withdrawing altogether. Real estate remained challenged due to reduced foot traffic, the prevalence of remote work, and elevated interest rates.
While most stocks and bonds experienced a challenging month, commodities and precious metals had a more nuanced performance. Gold struggled, but silver showed positive gains. Oil emerged as the month’s winner, propelling energy stocks to positive returns, making it the only sector in the S&P 500 to do so. Energy has played a role in defensive positioning this year, offering attractive dividends and benefiting from OPEC+ production cutbacks, potentially driving oil prices higher. This stands in contrast to most commodities, which experienced significant declines, making it an area to monitor as we continue to assess inflation trends.
Our team of professionals continues to evaluate the balance between the risks associated with U.S. stocks, the yields provided by fixed income, the valuations of foreign stocks, and the risk mitigation offered by precious metals. With positive returns in most asset classes this year, now is an opportune time to review your portfolio’s risk profile and consider whether adjustments are warranted.
Investment commentary by Jason Flores, CFA, CAIA – Executive Vice President & Chief Investment Officer at Central Trust Company.
If you would like to access our full monthly outlook and additional investment commentary, visit our Investments Learning Center. As always, if you have questions or concerns, please reach out to your team here at Central Trust Company, we are always ready to help.