As the calendar flips to August, let’s reflect on a bullish July that showcased the emergence of sector rotation.

Equity markets concluded July on a positive note, with the S&P 500 registering a modest gain of just over 1%. This marks the eighth monthly gain in the past nine months for the index.

Key sectors contributing to this performance were real estate, utilities, and financials. In contrast, the technology and communication services sectors, which have been significant drivers of year-to-date gains, took a logical breather, ending the month lower.

U.S. small-cap stocks shined in July, with the Russell 2000 Index surging over 10%, marking its best monthly performance since December. This ascent led to a notable outperformance margin of around 9% compared to U.S. large-cap stocks, the largest gap since February 2000.

Mid-cap stocks also enjoyed robust returns, with the Russell Mid-cap Index climbing 4.7%. The superior performance of small- and mid-cap stocks relative to large-cap stocks can be attributed to easing inflation and economic indicators suggesting moderate but stable economic growth, which favored the more economically sensitive sectors.

On the international front, developed large-cap stocks and emerging-market stocks also finished the month on a high note. The MSCI EAFE Index gained nearly 3%, while the MSCI EM Index saw a more modest rise of less than 1%.

In the fixed-income arena, U.S. investment-grade bonds benefited from declining yields, with the Bloomberg U.S. Aggregate Bond Index advancing over 2% in July.

Soft economic data has driven down bond yields. On Friday, the 10-year U.S. Treasury yield closed at 3.79% and the 2-year yield at 3.88%. The benchmark 30-year Treasury yield slipped to 4.10% (see chart):

Recent economic data releases have included second-quarter labor productivity, initial jobless claims, and manufacturing activity. The numbers all point to lower growth and subdued inflation.

Nonfarm business-sector labor productivity increased by 2.3% quarter-over-quarter, surpassing expectations of 1.8% and significantly higher than the first-quarter reading of 0.4%.

This productivity boost led to a rise in unit labor costs of only 0.9% in the second quarter, below the anticipated 1.7% increase.

Initial jobless claims for the past week were 249,000, exceeding expectations of 235,000 and marking the highest level this year. Despite this increase, jobless claims remain below the 20-year median of over 300,000.

The July ISM Manufacturing PMI fell short of expectations, indicating that higher interest rates continue to weigh on manufacturing activity. The employment subindex dropped to its lowest level since 2020.

A surprisingly “bad” labor report arrived Friday, although for investors eager for a rate cut, it could be interpreted as “good.”

The Labor Department reported Friday that job growth in the U.S. stalled more than expected in July as the unemployment rate inched higher.

Nonfarm payrolls climbed last month by only 114,000. That’s significantly lower than the downwardly revised 179,000 payrolls added in June and below the consensus estimate of 185,000 jobs.

Unemployment rose from 4.1% in June to 4.3% in July, the highest percentage in nearly three years although still the lowest since 1969.

The report also showed that average hourly earnings rose 0.2% from June to July and 3.6% on a year-over-year basis, below the analyst forecasts of 0.3% and 3.7%, respectively.

U.S. equities broadly fell Friday on the latest labor market news, closing as follows:

• DJIA: -1.51%
• S&P 500: -1.84%
• NASDAQ: -2.43%
• Russell 2000: -3.52%

After their huge run-up, small caps (as reflected by the Russell 2000) were poised for a pullback. The CBOE Volatility Index (VIX), aka “fear gauge,” jumped nearly 26% to hit 23.39, a whopping single-day increase that reflects a sudden rise of stress and anxiety in the markets.

Cumulatively, this week’s economic data suggested continued moderation in growth, inflation, and labor market conditions, paving the way for Federal Reserve rate cuts in the near future. Near term, though, stocks have taken it on the chin.

Solid corporate report cards…

A major pillar of the bull case remains corporate earnings. As earnings season progresses, approximately 68% of S&P 500 companies have reported their second-quarter results, with about 78% surpassing earnings expectations.

The average analyst expectation is for the S&P 500 to rack up a year-over-year Q2 earnings gain of roughly 10%. This solid performance highlights the resilience of many companies in a challenging economic environment.

Amazon (NSDQ: AMZN) and Apple (NSDQ: AAPL) reported their operating results after Thursday’s closing bell.

Amazon disappointed with a revenue miss and cautious guidance, signaling increased consumer wariness. Conversely, Apple achieved record revenue despite flat iPhone sales and sluggish demand in China, with CEO Tim Cook highlighting the company’s ongoing investments in artificial intelligence (AI).

A headwind for Big Tech, particularly Apple, is China’s sputtering growth. China this week released weaker-than-expected July manufacturing data, stoking fears of a global economic slowdown.

In the coming days, the focus will remain on corporate earnings and potential policy shifts from the Fed. The betting on Wall Street is that the central bank will cut rates at its September meeting, a move that would likely give stocks a jolt of adrenaline.

Meanwhile, some analysts are worrying that perhaps the Fed has been waiting too long to ease and might gratuitously trigger a recession, thereby snatching defeat from the jaws of victory. Just when a soft landing seemed in the cards, this week’s economic data possibly undermine that narrative.

If the Fed doesn’t cut in September, the central bank will have, as Ricky Ricardo might put it, “a lot of ‘splainin’ to do.”

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John Persinos is the editorial director of Investing Daily.

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