July Market Commentary

Following the tumultuous aftermath of the Brexit vote in June investors were pleased to see the market deliver a strong month in July. The S&P 500 rose 3.7% and the Russell 2000 6%, verifying the trend we noticed in mid-July, as stocks largely outperformed second quarter earnings estimates. The S&P 500 is now up 7.7% year-to-date and the Russell 2000 8.3%.

SS Bar Graph 7 16

Small stocks are often viewed as riskier investments so when the market sentiment switches “risk-on,” as it did in July, these stocks often outperform. They also tend to be more focused domestically than their larger peers, shielding themselves from some overseas risk and a strengthening dollar. The long-term trend still favors large-cap stocks as the recent small-cap shift was not strong enough to change the trend, but this is something to watch closely over the coming months.

Size Cycle Chart 7 31Growth stocks slightly outperformed value stocks in July but not nearly enough to change the year-long value edge. Value stocks haven’t seen as large of a 12-month performance edge relative to growth-stocks since the early 2000’s. While there is some evidence that small-caps are gaining momentum vs. large-caps, there is much less evidence of a similar shift with style.

Unsurprisingly given the relative outperformance of small-growth stocks, the Information Technology, Healthcare and Consumer Discretionary sectors all bounced back in July. For each of these sectors, nearly all of their year-to-date return is attributable to July. Defensive sectors have still outperformed year-to-date but now all sectors are in positive territory for the year.

Sectpr Bar Graph 7 16

While VIX dropped below recent lows as the market reached new highs, the yield curve narrowed, squeezed both by falling long-term interest rates and rising short-term interest rates. We watch the yield curve because of its utility as a leading indicator for the economy’s health. A narrowing term spread can be a warning sign and a negative term spread typically signals a recession on the horizon. Falling long-term rates in the past were the result of a slowing US economy but there is reason to believe the yield curve compression is not likely signaling a recession ahead this time. External factors that don’t have anything to do with the US economy – Brexit, international weakness, global search for yield – are the primary drivers in Treasury yields making the term spread less reliable than usual.

Term Spread 7 16

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