Stock Market Ends Volatile Week on High Note Amid Mixed Economic Signals

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Stocks had a mixed and volatile week but regained ground on Friday as more conflicting data gave hope to the idea of a soft landing. Much as we have forecasted, investors have continued to rotate into less expensive parts of the market as hopes for lower interest rates look set to get a boost in the coming months. This repositioning has pushed Small Cap and Mid-Cap stocks up 10.3 percent and 5 percent respectively month to date. Meanwhile the S&P 500 index of Large Cap stocks has been flat, held back by the so called “Magnificent Seven,” which had previously driven market performance over the past several months—but are now down 4 percent.

The question remains: Will lower rates lead to a soft landing, or will they be too little and too late with the U.S. economy eventually falling into a recession? Recession or not, we believe interest rates are likely headed lower in the near term. While the data is still conflicting, the U.S. economy appears to be weakening. If a soft landing were to occur, we believe that path would be paved by a Fed that will be lowering rates to ease the growing impact on consumers and corporations. Conversely, if a recession takes hold, we believe it would lead to the Fed cutting interest rates to cushion the blow. This “optionality” is why we continue to favor the less expensive, more rate-sensitive segments of the U.S. markets.

The soft-landing narrative got a boost at the end of the week with the latest Personal Consumption Expenditures (PCE) index—the Fed’s preferred measure of inflation. The numbers show inflation rising 0.1 percent during June and 2.5 percent year over year. Core PCE (which strips out volatile food and energy prices) was up 0.2 percent and is now up 2.6 percent year over year.

This second straight month of good inflation numbers comes on the heels of an inflation resurgence to begin the year. Given the ebbs and flows of the inflation data over the past year, we believe the Fed is looking for further evidence that inflation is sustainably back to 2 percent. While the shorter-term trends look favorable, the intermediate-term trend still shows “sticky” inflation. For example, six-month annualized core inflation is running at 3.4 percent, while “super core” services (excluding housing) check in at 4.1 percent.

The early 2024 spike in inflation seemingly coincided with the Fed expressing optimism at the end of 2023 that inflation was in the rearview mirror. Investors took that narrative and priced in six rate cuts for 2024, which caused markets to advance strongly as consumers became optimistic. The Fed must wonder whether this chain of events paved the way for that inflation resurgence.

With that, we’ll be keeping a close eye this week on the Federal Open Markets Committee meeting. We think it’s highly unlikely the Fed will cut rates. All eyes then shift to September. We’ll be paying close attention to Fed Chairman Jerome Powell’s news conference this week for any evidence of how the Fed is thinking about its next meeting. While a soft landing remains possible, the longer rates remain elevated, the greater they’re likely to impact the overall economy. A soft landing is certainly still a possibility, but we think the Fed is likely going to want to see more clear evidence that inflation is under control or that the labor market is dramatically weakening before it’s willing to lower rates.

Wall Street wrap

GDP exceeds Wall Street expectations: The initial estimate of second-quarter real gross domestic product (GDP) growth from the Bureau of Economic Analysis came in at 2.8 percent, exceeding Wall Street expectations of 2 percent. The increase was driven nearly equally by consumer and business fixed investment spending. On a year-over-year basis, real GDP checked in at 3.1 percent, with nominal GDP (including inflation) running at 5.8 percent. These are strong numbers that are above what many consider to be sustainable in the long run—especially when you consider that nominal GDP is above the Fed funds rate. More importantly, it would be unusual for the Fed to cut rates amid such strong growth.

Existing home sales continue to fall while median sales prices set new record: The National Association of Realtors reported that existing home sales in the U.S. fell 5.4 percent into a seasonally adjusted annual rate of 3.89 million units. The decline marks the fourth consecutive month of declining sales and is the slowest pace of home sales in the month of June since 1999. The decline in sales occurred despite an increase in activity in the high end of the market, with sales of properties of $1 million or more up 3.6 percent from year-ago levels. This highlights how higher interest rates are weighing on less affluent consumers while having a less significant impact on wealthy households.

While sales once again declined, prices continued to edge higher. The median price for existing single-family homes rose to $426,900 in June, an increase of 4.1 percent from year-ago levels and the highest amount on record. The latest figure marks the 12th consecutive month of year-over-year price gains.

There is a 4.1-month supply of unsold inventory, the highest level since May 2020. Historically, a five-month supply of inventory is consistent with moderate price appreciation. A steady uptick in supply may eventually start to ease price pressures on homes, as current high mortgage rates have made long-time homeowners who have fixed-rate mortgages at much lower rates hesitant to sell. As a result, we expect it may take a while for the inventory level to cap price gains.

New home sales continue to decline: Similar to existing home sales, new home sales also declined again in June to 617,000 units, according to the latest data from the U.S. Census Bureau. This figure is down 0.6 percent from May’s revised total of 621,000. On a year-over-year basis, new home sales are down 7.4 percent from the June 2023 estimate. The median price of a new home was essentially flat, coming in at $417,300, down from $417,400 in May.

Business activity increases while prices cool: U.S. business activity climbed again in July. The latest preliminary data from the S&P Global Composite Purchasing Managers Index, which tracks both the manufacturing and service sectors, shows that the Composite Output Index came in with a reading of 55 (levels above 50 indicate growth), up 0.2 points from June’s final reading of 54.8.

Optimism about output in the year ahead fell to a three-month low in July, dropping even further below the survey’s long-run average. Sentiment was negatively impacted by uncertainty surrounding the presidential election and resulting policies, although businesses also cited concerns over the continued high cost of living relating to both inflation and interest rates.

Employment rose for the second month in a row, indicating a further modest labor market improvement after headcounts fell briefly in the two months since May. Manufacturers reported the stronger rate of increase, although both sectors reported weaker payroll gains than in June.

Average prices charged for goods and services rose at the slowest rate since January and the second-slowest rate since October 2020. While some stubbornness of inflation was still evident in the services sector, prices charged for services rose on average at the slowest rate for almost four years (barring only January’s brief dip in the rate of inflation).

Durable goods orders may point to weakness in the economy: Preliminary results for June showed that durable goods orders fell 6.6 percent. While economists often shrug off this volatile number, the report also contains capital goods orders and shipments (non-defense, excluding transportation data) that are viewed as proxies for overall business spending. Capital goods orders rose 1 percent, but that comes on the heels of a 0.9 percent decline in May. On a year-over-year basis capital goods orders are down 2 percent. Capital goods shipments rose 0.1 percent after a 0.7 percent decline in March, which pushed the year-over-year number to negative 3.01 percent. Interestingly, on a three-month annualized change, shipments have fallen 2.3 percent. While business spending was strong in GDP, these numbers point to potential weakness under the surface.

Continuing jobless claims ease: Weekly initial jobless claims were 235,000, down 10,000 from last week’s upwardly revised level. The four-week rolling average of new jobless claims came in at 235,500, an increase of 250 from the previous week’s average.

Continuing claims (those people remaining on unemployment benefits) stand at 1.851 million, down 9,000 from the previous week’s revised total. The four-week moving average of continuing claims came in at 1.8535 million, an increase of 4,750 from last week and the highest level since late 2021.

The week ahead

Tuesday: The Bureau of Labor Statistics will release its Job Openings and Labor Turnover Survey report for June. We’ll watch for whether the gap between job openings and job seekers is continuing to narrow, which would help ease wage pressures for businesses. We’ll also keep an eye on the so-called “quits” rate to see if workers are feeling confident in their ability to find different or better jobs.

The Conference Board’s Consumer Confidence report will come out in the morning. Given the Fed’s ongoing focus on the employment picture, we will continue to keep an eye on the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find and those who report challenges finding work.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following its monthly meeting. We expect the Fed will hold rates steady, but may open the door further for a rate cut in September.

Thursday: Initial and continuing jobless claims will be out before the market opens. Continuing claims trended lower last week.

The manufacturing sector will be in focus as the Institute for Supply Management releases its latest Purchasing Managers Manufacturing Index. Recent readings show inflation pressures for manufacturers have risen as activity in the sector has perked up. We will monitor it for signs of additional price pressures and the pace of growth in activity.

Friday: Employment will be in the picture as we get numbers on jobs, the unemployment rate and wages. We’ll be watching for any softening in the labor market, which will be a key factor in the Fed’s comfort level when it comes to future rate reductions.

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