By Daniel McGarvey, Portfolio Analyst
The S&P 500 ended July with a rally that gave investors some signs of hope that the worst of the year’s volatility is over. Interestingly, the rally took place during a time when the Federal Reserve raised rates another 0.75%, GDP growth came in as negative for the second quarter, and inflation remained elevated. It is possible that the market had priced in those expectations beforehand and reacted positively to finding out that they weren’t worse than expected. Still, it’s also good to keep in mind that bear market rallies are quite common and not necessarily a sign that a bottom has been reached.
For example, the global financial crisis saw many rallies followed by further declines (see S&P 500 Index chart below), as did the dot-com crash. We do not think our current situation is nearly as dire as those two examples, but there are still a number of potential negative catalysts lurking, and rallies should be viewed with some caution.
The bond market also rallied through July, but it is still in the midst of one of its worst and most volatile years in history. Volatility has come as it has been trying to anticipate what is next for the economy throughout the Fed’s rate hike regime. Interest rates are now beginning to imply that the Fed may pivot and start lowering rates as early as mid-2023. These expectations can change from day to day. Some volatility is likely to remain until there can be more certainty about the economic situation, but going forward, the return profile for bonds is far more attractive than it was to start the year. Furthermore, we believe bonds can go back to being a good diversifier for equities.
The S&P 500 returned 9.22% in July and -12.58% year-to-date amid continued uncertainty regarding inflation, rate hikes and geopolitical conflict. The 10 Year Treasury rate dropped dramatically from its June highs to end the month at 2.64%, and the yield curve inverted again. The Bloomberg US Aggregate Index had its best month of the year with 2.44% returns, and high yield spreads tightened from 5.92% to 4.98%. Oil prices are still high but retreated in July, with WTI crude oil falling from around $108/barrel to $95.
Charts provided by Strategas Research Partners, LLC.