US equity markets are primed to stretch a bull run into September after recovering from a sell-off that sparked volatility in early August, an event that likely served as a necessary reset following a red-hot July.
The S&P 500, Nasdaq Composite and Dow Jones Industrial Average indexes respectively lost 7.90%, 12.30% and 3.75% in value from July 16 to Aug. 5. The group of seven mega-cap technology stocks — collectively known as the Magnificent Seven — lost a combined $1.319 trillion in market capitalization, or about 9%, from July 31 to Aug. 5. However, the dip was short-lived, as each of the three indexes regained their losses by mid-August and have resumed a general rise.
Many factors contributed to the downward pressure at the start of the month, including the unwinding of the yen carry trade, a weaker-than-expected jobs report and the Federal Reserve's July decision to maintain its benchmark interest rate near a 20-year high. Renewed upward momentum could be supported by bullish developments in recent weeks from retail sales and jobless claims data, alongside the Aug. 23 signal from Fed Chairman Jerome Powell that rate cuts are likely to begin in September.
"While we saw a market correction in August for the Nasdaq, defined by a 10% pullback, we did not quite get there with the S&P 500," said Kevin Philip, a partner at Bel Air Investment Advisors. "Corrections are healthy and regularly occur. We continue to believe the US economic backdrop remains favorable to mid and long-term equity returns."
Moreover, the early August slide in US indexes served as a surprisingly late iteration of the typical summer slowdown, and the rebound appears to be undisrupted after a "welcome reset to the health of the equities market," said Jeff O'Connor, head of market structure for the Americas at Liquidnet.
"There haven't been any aftershocks following the volatility and volume burst of early August, and the return to normalcy has been orderly and quick," O'Connor said. "Barring any surprises, we can expect the market to maintain a steady trajectory into September."
Volatility still on the horizon
Volatility in equity markets spiked at the start of August, with the CBOE Volatility Index jumping 64.90% on Aug. 5 from Aug. 2. The index, which measures the 30-day expected volatility of the US stock market, has since retreated to levels more consistent with the rest of the year.
With volatility seemingly scaling back, any lingering concerns should subside because market fundamentals remain largely unchanged, Philip with Bel Air Investment said.
"A large part of the correction was a technical unwind of the carry trade with a change in interest policy in Japan," Philip said, referring to a strategy that involves investors borrowing a currency in a low-rate economy and using those funds to buy securities based on a higher-rate currency. "We are not particularly concerned as our outlook on the US economy and direction of interest rates should be favorable to markets."
While August's turbulence has abated, volatile conditions could persist in the coming weeks, said Ken Wattret, vice president of global economics at S&P Global Market Intelligence.
"The exceptional volatility at the start of the month ought to be viewed in the context of 'thin' markets, frothy equity valuations and an overreaction to the noise in some weaker-than-expected US economic data," Wattret said in an Aug. 16 report. "The path forward will likely remain bumpy given numerous US-related uncertainties, including the risk of a hard landing, the timing and magnitude of policy rate cuts, the outcome of elections in November and their policy implications."
Wattret said Japan's monetary policy prospects and the ongoing effects of the yen carry trade will also likely remain a source of market volatility.
IT, real estate among most promising sectors
Stocks within the information technology and real estate sectors appear to have the most upside as markets continue a rebound at the end of August.
Among the S&P 500's 11 market sectors, stocks within the IT sector collectively experienced the second-largest drop in year-to-date value on Aug. 5 but have since reached the biggest year-to-date gain as of Aug. 26.
Within the technology sector, telecommunication infrastructure providers and services involved with machine learning and AI are poised to perform strongly after showing negative returns in the first half of 2024, said Rahul Sen Sharma, president and co-CEO of index provider Indxx.
"These two sub-themes have witnessed significant gains and delivered more than 10% returns in the first 20 days of August," Sen Sharma said. "Conversely, we anticipate underperformance from automobile-related themes, including industrial and construction vehicle leasing, consumer vehicle retail, and automotive subscription services."
Treasury yields seen stabilizing
US Treasury trading did not experience the same degree of volatility as equities in August. Still, uncertain conditions in the stock market did stem a downward trend since April that brought some key bond yields down to their lowest levels of the year by Aug. 5.
The 10-year Treasury bond yield was 3.84% on Aug. 26, while the 2-year yield was 3.83%.
The spread between the two yields has mostly remained negative since July 2022, causing an inversion to part of the Treasury yield curve that has historically preceded an economic recession. The recent narrowing of the spread could provide a bullish indicator for the economy through the end of the year if the 10-year bond yield holds at its current level amid a slate of optimistic inflation data.
"The yield on the 10-year Treasury note has dropped 40 [basis points] in just a few weeks' time, and stocks have resumed a 'rise on fume mode' following the early August drawdown," Liquidnet's O'Connor said. "So far, treasury moves have reflected the economic data and supported the deflationary narrative."