A large rotation to Value-oriented and Small-Cap stocks caused volatility to increase during the month of July. The VIX Index, a commonly used gauge for volatility in US equities, rose from 12.44 to as high as 19.36 before settling at 16.36 at the end of the month. The rotation caused the Russell 1000 Value and Russell 2000 to outperform, posting returns of 5.11% and 10.16%, respectively. Driving this rotation was favorable inflation readings, optimism of a US Federal Reserve rate cut in September, falling interest rates and disappointing earnings announcements from Large-Cap Growth companies.
The most recent US Consumer Price Index (CPI) reading was released on July 11th and was the first catalyst for many investors to shift their focus to Small-Cap and Value-oriented equities. Year-over-year inflation was reported at 3.0%, below the estimate and prior reading of 3.1%. Core CPI, which excludes the costs of Food and Energy, rose at a year-over-year rate of 3.3%, also below analysts’ estimates which were at 3.4%. There was a rise in the cost of Core Services, which was the largest contributor to the year-over-year reading. Increases were also seen in the cost of Energy and the cost of Food. The cost of Core Goods continued to fall and be the only detractor to year-over-year CPI.
Month-over-month CPI was not only announced below the street’s estimates but showed signs of declining prices. The number was reported at -0.1%, below the estimate of 0.1%. The cost of Energy was the primary driver of the negative reading with cost of Core Goods also falling. The cost of Core Services saw the largest increase and was followed by an increase in the cost of Food. On the day of the announcement, Small-Cap equites rose as the Russell 2000 returned over 3.5%. Growth-oriented companies fell as the Russell 1000 Growth declined 2.11%.
The US FOMC met on the last day of the month and announced that there would be no change to the target rate and that it would remain between 5.25% and 5.50%. Messaging from the statement brought balance back between the FOMC’s dual mandate which is stable inflation and employment. The change in tone implied that the officials will be paying close attention to future employment readings such as Nonfarm Payrolls. An unexpected spike in unemployment has the potential to be met with faster easing of monetary policy. However, this would also signal that the economy is weakening at a quicker pace than what the FOMC is anticipating. Moreover, the unemployment rate has risen over the past few readings. Further increase could lead some to believe the US may be entering a recession.
Coinciding with the positive inflation data and adjusted expectations of when the US Fed with cut rates, interests rate continued their move down throughout the month of July. The US Treasury 10yr yield fell from 4.40% to 4.03% while the 2yr fell from 4.75% to 4.26%. A monthly move down in the yield of this size had not been seen since December. Also, prior to the FOMC meeting, Bloomberg showed that investors were anticipating the first rate cut to arrive in September with a possibility of the second arriving in December. After the close on the July 31st, it was shown that investors fully expected the second to arrive by the end of the year.
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