Thrivent Asset Management Contributors to this report: Steve Lowe, CFA, Chief Investment Strategist; John Groton, Jr., CFA, Director of Administration and Materials & Energy Research; Matthew Finn, CFA, Head of Equity Mutual Funds; and Jeff Branstad, CFA, Model Portfolio Manager

U.S. stocks rallied again in July, with both the S&P 500 Index and the NASDAQ Composite Index generating the strongest performance in the first seven months of a year since 1997. July’s performance was notable for seeing a rise in all 11 sectors of the S&P 500 Index, led by Energy, which was supported by a surge in oil prices over the month.

Sustained, if moderate, strength in economic data supported the markets’ gains and prompted the U.S. Federal Reserve (Fed) to again raise interest rates by 0.25% at its July 26 meeting, citing the “moderate pace” of economic activity, “robust” job growth, and “elevated” inflation in their public statement.

Indeed, the Personal Consumption Expenditures (PCE) Index rose 3% for the 12 months ended June 30, 2023, according to the July 28 report from the Commerce Department. While the rate declined for the second consecutive month, the core PCE Index (removing the more volatile food and energy components) increased 4.1% from last June and remains well above the Fed’s target rate near 2%.

While geopolitical news was relatively light in July, oil prices were strong over the month and Saudi Arabia added fuel to that rally when they announced in early August that they would be extending their current production cuts.

More dramatically, Fitch Ratings announced on August 1 that they were downgrading the U.S. government’s long-term rating to AA+ from AAA, with a stable outlook. In their press release, Fitch cited the expected deterioration of the country’s fiscal accounts in the coming years, the growing deficit, and the “erosion of governance” manifested in “repeated debt limit standoffs and last-minute resolutions.”

While long-dated Treasury yields had risen over the period on sustained economic activity, the news has pushed the yield of the 10-year bond towards its one-year highs near 4.25%. 

Outlook: 

The U.S. economy has proven resilient to persistently high inflation, rising interest rates, ongoing geopolitical instability, and even domestic banking failures. A strong labor market, fueling solid consumer spending, has helped both economic growth and market optimism but in our view a slowdown and possible recession has most likely not been averted, just delayed. 

Consider the consumer: consumption has been robust, surprising to the upside. At the same time, adjusted for inflation, spending has softened. Delinquencies are increasing on the margin and the surge in excess savings that accumulated during the pandemic has been whittled lower. Meanwhile, the strong job market that provided consumers’ confidence remains robust but has shown signs of softening. More broadly, leading economic indicators continue to point to a more challenging environment over the coming quarters, and the yield curve remains severely inverted – which has often been a precursor to a recession. Certainly, the combined rate hikes from central banks across the world are likely to be draining financial liquidity. And while the economic impact of this lags, we think it is a question of when, not if, the economy feels its full impact.

While it is true that the current, more sanguine, economic environment has led to better than expected overall corporate earnings and equity returns in recent months, these have been influenced by a very small number of mega-cap, technology-oriented stocks sparked by (justifiable) enthusiasm for artificial intelligence (AI) and all the infrastructure it requires. Furthermore, profit margins look to us to have peaked. Broad-based corporate profitability, while better than expected, has been buoyed by the ability to raise prices in a stimulus-driven inflationary environment. But in an environment of slowing inflation and economic growth, it will be more difficult for corporate profits to continue to beat expectations.

However, we do think the market is right to see AI as the spark for a new, emerging trend fueling technology investment, and we think it’s worth keeping an eye on small cap stocks. If history is any guide, the time to increase exposure to this sector is when the economy is in, or clearly headed into, a recession.

But turning points in the U.S. economy are notoriously difficult to time. And today’s more globalized economy adds additional complications as geopolitical wild cards abound. Might we see a post-Putin Russia in the second half of 2023? How, and when, will the tensions between China and Taiwan be resolved? How convoluted and disruptive might the 2024 U.S. Presidential election become in the coming quarters? In this uncertain environment we encourage equity investors to stay focused on the longer-term trends and – absent clarity – wait patiently for clearer signs of the economy’s direction.

In the meantime, both short and intermediate government bonds, with current yields of 5-5.5%, continue to look compelling if the market is right that there are only a few (or less) interest rate hikes remaining. Longer-dated U.S. Treasury bonds also deserve a closer look as they, like small-cap stocks, historically perform well as the economy turns into a recession.

Mortgage-backed securities are another sector which look appealing given their combination of relatively high credit quality and yields near 5%. While similarly rated investment-grade corporate bonds are also attractive, we do not see the same value in the lowest spectrums of the corporate credit market, where high-yield bonds look rich insofar as any further economic weakness will weigh more heavily on the lower-rated segments of the corporate bond market. Bottom line, the credit markets, like the equity markets, can be attractive to buy-and-hold investors, but the likelihood of high shorter-term volatility and geopolitical uncertainty makes a long-term view a necessity.

Drilling down

U.S. stocks march higher

The S&P 500^® Index rose 3.11% in July, from 4,450.38 at the June close to 4,588.96 at the end of July. The total return of the S&P 500 Index (including dividends) for the month was 3.21% and 20.65% year to date. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 U.S. large capitalization stocks.)

The NASDAQ Index rallied again in July (up 4.05%) from 13,787.92 at the end of June to 14,346.02 at the July close. For the year, the NASDAQ was up 37.07% through July, as technology stocks accelerated their rebound off large losses in 2022. (The NASDAQ – National Association of Securities Dealers Automated Quotations – is an electronic stock exchange with more than 3,300 company listings.)

Retail sales rise

Retail sales were up 0.2% from the previous month in June, and up 1.5% from 12 months earlier, according to the Department of Commerce retail report issued July 18. Rising sales were led higher in the month by non-store retailers, and food services & drinking places, furniture & home furnishing stores, and electronics & appliance stores.  

The gains were more impressive on a year-on-year basis, with non-store retailers (primarily online sales) leading, up 9.4% from June of last year as consumer spending remained strong. Consumers also remained active in restaurants and bars, with food and drinking establishment spending up 8.4% year-on-year. Health & personal care stores sales were also strong, up 6.3% from June last year.

Falling sales at gasoline stations (down 1.4%), building materials and gardening supplies (down 1.2%), and grocery stores (down 0.7%) weighed on retail sales in June, while gasoline stations continued to lead retail sales lower on a year-on-year basis, down 22.7% from June last year, despite oil prices rising over the month. 

Job growth is tepid

The U.S. economy added 187,000 new nonfarm jobs in July, according to the Department of Labor’s (DOL) August 4 report. Both the unemployment rate, at 3.5%, and the total number of unemployed people, at 5.8 million, were relatively unchanged from the prior month.

The number of new jobs added was below consensus expectations (near 200,000) and significantly less than the average monthly gain of 312,000 over the past year, though similar to June’s gain of 209,000 jobs. Health care added the most employees (63,000), followed by social assistance (24,000), and financial activities (19,000).

The number of part-time employees, at 4.0 million, was little changed in July, while average hourly earnings for all employees rose 0.4% in July and 4.4% compared to July of last year, signaling there is continued upward pressure on wages.

All sectors rose in July

The S&P 500 Index saw broad-based strength in July, with all 11 sectors generating a positive return. Energy was the best performing sector for the month, rising 7.40% in July and bringing its year-to-date return to 1.47%. Communication Services was not far behind, up 6.94% over the month, while Financials staged a comeback with a 4.85% return in July, bringing its year-to-date return positive, up 4.30%.

All other sectors, except Real Estate (up 1.25%) and Health Care (up 1.02%), rose more than 2% over the month. With the broad-based returns in July, nine of the 11 sectors now have a positive year-to-date return, with only the Utilities sector (down 3.36%) and Health Care (down 0.48%) still in the red. 

The chart below shows the past month and year-to-date performance results of the 11 sectors:

Treasury yields rise

The yield on 10-year U.S. Treasuries rose from 3.81% at the end of June to 3.95% at the July close, as stronger economic data drove yields higher.

The Bloomberg U.S. Aggregate Bond Index was down 0.07% in July. (The Bloomberg U.S. Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment-grade bonds traded in the U.S.)

Oil prices swell

Oil prices surged in July, as strong demand coupled with declining supply from oil producing countries pushed prices higher. A barrel of West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, rose 15.8%, from $70.64 at the end of June to $81.89 at the July close. On August 3^rd, Saudi Arabia announced it will voluntarily extend its 1 million barrel per day cut in production into September and noted that production cuts could be further extended or even deepened.

Gasoline prices at the pump rose modestly in July. The average price per gallon rose from $3.69 at the end of June to $3.71 at the end of July. 

International equities rally

International equities were relatively strong in July after a stretch of disappointing returns, at least when compared to the S&P 500 Index. The MSCI EAFE Index rose 3.17% for the month, from 2,131.72 at the end of June to 2,199.36 at the July close. The index, which tracks developed-economy stocks in Europe, Asia, and Australia, extended its year-to-date gains, up 13.14% at the July close.