3 moments that defined August

August slipped away like a moment in time. Summer went by in a flash—but not without some excitement. We saw the S&P 500 hit its 38th all-time high in July (marking a 19% return on the year) before an -8.5% pullback in August. But the whiplash was short-lived. Stocks quickly recovered, and now sit within touching distance of all-time highs. Outside of stocks, perhaps the most important news of the summer for investors is that the Federal Reserve is now (finally) prepared to cut rates.

In this week’s note, we highlight the three moments that defined August as we set course for the upcoming rate-cutting cycle. 

3 moments that defined August

1. The unemployment rate rose. The July labor market report, released on August 2, undershot expectations across nearly every metric. Notably, the unemployment rate rose to 4.3% from 4.1% in June, triggering the ominous “Sahm Rule”, which often coincides with recessions.

Global risk-assets suffered in the days following the release, and the unwind of popular “carry trades” exacerbated the moves.

The VIX Index, a measure of implied S&P 500 volatility, spiked to levels seen only during the onset of the COVID-19 pandemic and the throes of the Global Financial Crisis. Stocks around the world slid while core bonds demonstrated their defensive characteristics.

The July labor market data made one thing clear: The health of the U.S. labor market is a bigger concern than inflation. This, and the sell-off in risk assets, sent a clear message to the Fed: It’s best not to “mess around and find out” what further weakness could look like or lead to in either markets or the economy. That balance of risks looks more finely balanced on this side of the pond, but the ECB and BoE are underway with gradual cuts of their own.

2. Investors bought the dip. Using stock market pullbacks to increase equity exposure can be a powerful strategy, especially for those sitting on the sideline with excess cash positions. August’s drawdown was about -8.5% from July highs, and since the lows, the S&P 500 is up +9%—not too shabby. In fact, average returns for the S&P 500 12 months after a 5% pullback are nearly 12%, and markets are higher almost 75% of the time. 

This time around, it seems like investors did their homework. Active trading on our platform increased by 55% during the August sell-off, and over 70% of the action was to buy equities. 

Strong fundamentals helped make the case to buy the dip.

• The S&P 500 is on pace to have its best earnings season since the first quarter of 2022—growing profits about 12% over the prior year. While Big Tech has driven a lot of the growth thus far (19%), a broadening has continued to take shape. Seven of the 11 sectors have exceeded analyst expectations. But that hasn’t always translated into a positive stock reaction, with the bar for earnings growing increasingly high. Look no further than Nvidia last week.
• Even more important: Those earnings are higher quality. Profit margins (which show how much profit a company makes from each dollar of sales after all expenses are deducted) are around 10.5% for the quarter so far. That’s a slight bump up from last quarter and above the five-year average.
  

We believe the bull market has room to run. In fact, the median bull market lasts 46 months (about three times longer than the average bear market). The S&P 500’s current bull run is only 22 months young. If it were to merely meet the historical median, that would mean it could extend for two more years.

3. The Fed signaled that cuts are here. Fed Chair Jerome Powell said it himself at the recent Jackson Hole Economic Policy Symposium: “The time has come for policy to adjust.” While the pace and magnitude may vary, the direction is clear: Policy rates are heading lower. Rate cuts ought to support the economy and the labor market by incentivizing more activity in areas such as housing, autos and capital markets.

If there is one thing investors should know from past rate-cutting cycles, it’s that cash is likely to underperform as yields fall. Cash has played a noble role in portfolios over the last two years and is a necessary part of any lifestyle. But even if policy rates settle in a higher range than the last cycle, today’s elevated cash yields won’t last forever.

We believe better opportunities outside of cash exist today, especially for long-term investors looking to grow and compound their wealth over time. Bonds, for example, may provide consistent income and downside protection, while equities may stand to provide long-term capital appreciation. Pockets of private markets can also provide a source of uncorrelated returns to help navigate through the cycle.

Despite the uncertainty, we continue to believe the cycle should power through a soft labor market, the stock market could have plenty of room to run, and investors should assess excess cash positions as central banks cut interest rates.

As always, your J.P. Morgan team is here to help think through what this may mean for you and your portfolio.