Fund investors felt some heat in the stock market in August.
Recession fears knocked the S&P 500 down 6.1% in the first three trading days of the month before slowdown fears ebbed. The market clawed its way back to finish higher.
Stocks overcame their slow start last month. Investors looked ahead to the Fed's next policy meeting on Sept. 17-18. Wall Street expects the Fed to cut rates by a quarter point or half point.
The S&P 500 posted a 2.28% gain, extending its year-to-date return to 18.42%, according to Lipper Refinitiv data. But the average U.S. diversified equity fund lagged the benchmark index with a 1.37% monthly gain and 14.22% return for the year.
Where's The High For The Stock Market?
Despite the stock market's August advance, there was one noticeable bullish data point missing. The S&P 500 did not notch a record high, after racking up 38 fresh 2024 highs through July, according to S&P Dow Jones Indices.
Stock investors now look ahead to September with caution. The back-to-school month is historically the worst-performing month of the year. The S&P 500 has declined 1.16%, on average, in September. And it has only gained 43.8% of the time, says S&P Dow Jones Indices.
Investors got a wake-up call. An economic downturn in the U.S. can't be ruled out in the wake of 11 Federal Reserve rate hikes from March 2022 to July 2023. The rate-hike cycle raised the central bank's key borrowing rate from zero to a range of 5.25% to 5.5%.
"We expect further bouts of volatility during September," said Quincy Krosby, chief global strategist for LPL Financial. "We are monitoring consumer discretionary flows versus consumer staples as a barometer or gauge on the strength of the economy."
Hoping For Lower Rates
Hopes for lower rates ahead haven't erased lingering fears. Some worry damage caused by higher borrowing costs may still be on the horizon. As a result, Wall Street will watch for signs of economic weakness. Investors will be closely eyeing the August jobs report.
The unwinding of the carry trade in Japan caused the CBOE Volatility Index (VIX), a market fear gauge, to jump over 300% and stocks to plummet in early August. Investors, borrowing capital in cheaper yen and investing the money in higher-yielding assets like U.S. stocks, began to unwind the trade after Japan hiked its ultralow interest rates.
Most major indexes, though, eked out gains in August. The Dow rose 1.76% and the Nasdaq composite gained 0.65%. The small-cap Russell 2000 was the laggard, dipping 1.63%. For the year, the S&P 500's 18.42% gain was best, edging the Nasdaq's 18% advance and outpacing the Dow, up 10.28% and the Russell 2000, up 9.40, by a wide margin.
Winners Shift In The Stock Market
In August, the momentum in once white-hot tech stocks slowed. Science and technology funds rose just 1.08% The best performers last month were defensive sectors. Real estate, which benefits from falling rates, was the leading sector performer, rising 5.24%. Utility funds jumped 4.03% — and their year-to-date gain of 19.05% is now tops among sector funds. Health and biotech funds rose 3.85%. And consumer goods stocks rallied 3.62%.
The only sectors to finish in the red in August were natural resources funds, off 3.17%, and materials, which finished 1.37% lower.
Real estate ETFs, which benefit when borrowing rates fall, fared well. Of the top 20 sector ETFs ranked by year-to-date performance, the top gainer in August was iShares Residential and Multisector Real Estate ETF. It jumped 9.38%, according to Morningstar Direct. iShares Cohen & Steers REIT ETF, rose 6.44%.
Finding Top ETFs
Other top ETF gainers included a slew of health care portfolios. iShares US Medical Devices ETF, finished up 7.18% in August. VanEck Pharmaceutical ETF rallied 6.82%. And Roundhill GLP-1 & Weight Loss ETF, a portfolio that invests in the increasingly popular obesity drugs, jumped 6.54%.
Large-cap stock funds fared better than mid- and small-cap funds. Large-cap value funds rose 2.43% and large-cap growth advanced 2.30%. The top-performing large-cap growth fund was JAG Large Cap Growth (JLGIX), up 5.04%. The No. 1 large-cap value fund was Federated Hermes MDT Large Cap Value (QCLVX), up 6.20%.
Small Caps Sputter
In contrast, mid-cap growth and mid-cap value funds rose 2.09% and 1.03%, respectively. Small-cap funds fared the worst. Small-cap growth eked out a 0.5% gain. And small-cap value funds declined 1.66%. Baron Discovery (BDFFX) led the small-cap growth leader board with a 4.62% rise. Aegis Value I's (AVALX) 2.95% advance was best of small-cap value funds.
The Magnificent Seven didn't perform as magnificently as they did earlier in the year. Only three of the seven megacap tech giants finished in the black in August. And the group trimmed the S&P 500's overall gain in August by 0.26%, data from S&P Dow Jones Indices show. So far this year through August, however, the Magnificent Seven still accounted for 45% of the S&P 500's total gain. S&P 500 index funds rose 2.39% in May and are up 19.18% on the year, according to Lipper.
Some investment pros stress that AI's runway for growth is still long. Nvidia bulls argue that the large price drop for the leading chipmaker presents a good time to buy shares.
"Investors shouldn't write off this chipmaker," says Nigel Green, CEO of deVere Group, a global wealth management firm. "They should consider using it as a buying opportunity and explore the wider AI ecosystem."
Bullish On AI
Jean Bovin, head of BlackRock Investment Institute, says despite investor worries about tech companies spending big on AI, investors should focus on the broader story. That means stay overweight the AI theme. "Patience (is) needed in the AI buildout," Boivin stressed in note to clients.
LPL's Krosby, however, says search data suggests that investor sentiment on Nvidia may be cooling. The bar for earnings is so high that it's getting harder for the chipmaker to impress Wall Street.
"Google search is seeing fewer and fewer searches for AI and generative AI, suggesting interest has waned following the explosive media attention to AI and Nvidia topping the mega-tech stock charts," Krosby said.
Laggards Pick Up
Value funds posted better returns than growth funds for the second straight month. Vanguard Value Index ETF rose 2.88%, which topped Vanguard Growth Index ETF's 2.27% gain.
International stock investing delivered solid returns in August, with the iShares MSCI EAFE fund, which invests in developed foreign markets, rising 3.24%, boosting its year-to-date gain to 11.83%.
Bond investors also had another good month of gains in August as rate cut odds rose and the outlook for the economy dimmed.
iShares Core US Aggregate Bond fund, which tracks a diversified basket of investment grade bonds, gained 1.44% to boost its 2024 gain to 3.17%, according to Lipper. Similarly, Vanguard Total Bond fund gained 1.38%, extending its year-to-date gain to 3.09%.
Waiting On The Fed
Price movements in the bond market going forward will depend in large part on the size of the Fed's first rate cut, says Leslie Falconio, head of taxable fixed income strategy at UBS Global Wealth Management. If the August jobs report shows a rise in unemployment, the odds of the Fed cutting half a percentage point could rise. That sets in motion a rally in fixed income.
"If the Fed goes 50 basis points out of the gate, then rates will likely decline (more sharply) as the market may perceive this as the Fed holding (rates too high) for too long, or the labor market showing greater weakness than anticipated," Falconio said. "(These signs would portend) slower growth and rising probabilities of a hard landing."
Currently, traders are placing 57% of odds of a quarter point cut in September. And there are 43% odds of half point cut. Market participants are also pricing in a full-point cut from current levels by year-end, according to CME Group's Fed Watch tracker.
Going For Quality
In the current rate environment, Falconio prefers bonds in higher-quality sectors. That way investors "can lock in yields." She says investment grade corporate bonds, particularly agency mortgage-backed securities (MBS) and municipal bonds, are well positioned to take advantage of falling rates.
"These bonds will offer good total return," said Falconio.
Overall, Falconio expects volatility to spike and advises bond investors to buy when prices fall. "We remain a buyer on the dips slightly over 4%," said Falconio.
