News and Events

By: DOUGLAS A. RILEY, CFA, PORTFOLIO MANAGER

July was an interesting month for financial markets with plenty of action to keep investors on their toes, not the least of which was the U.S. administration’s flip-flopping on their posture towards Iran. The on-again-off-again “peace talks” wreaked havoc with oil prices, which jumped from under $70 at the start of July to over $90 per barrel before dropping sharply in the final week on a pause in hostile activities and renewed hope for a deal¹. Unsurprisingly, bond volatility increased in July as traders digested the moves in oil and the USD along with favorable inflation data driven by the drop in crude from over $100 per barrel in May¹. Stocks, despite a major unwind of the AI trade, held up well in aggregate with REIT’s notably positive for the month in the face of rising interest rates¹. Hardest hit globally were South Korean equities, with the KOSPI Index falling more than -26%¹. Semiconductor memory stocks, SK Hynix and Samsung Electronics, which at their peak made up over 50% of the benchmark by weight, dropped -39% and -30%, respectively¹.  

The 10-Year U.S. treasury yield jumped 37 basis points to 4.73%, the highest monthly close since October 2023 and the second highest since June 2007¹. Spreads rose slightly but remain near the lowest levels in a quarter century¹. The Aggregate Bond Index lost -1.29% in July, pushing the YTD total return into negative territory¹. Bond investors became concerned with another potential spike in inflation reflecting the jump in crude due to renewed escalation in the Straight of Hormuz. Traffic has clearly slowed since a recovery in May-June, but oil continues to find its way into the global market. Otherwise, crude would likely be trading well above $100 per barrel. Though inflation could pick up again near term, as gasoline prices have moved higher again, to the extent that the increase is driven by higher energy costs perceived to be temporary, investors are likely to look past it.  

More difficult to look past are the changes at the Federal Reserve under new Chair Kevin Warsh. As expected, the Fed held rates steady at its July 29^th meeting, though there were three dissents calling for a hike. In keeping with his intention of deemphasizing forward guidance, Warsh has suggested that the Fed could eliminate the quarterly “Dot Plots” indicating where various Board members see rates in the future and possibly reducing the number of meetings held each year to as few as six from eight. So far, the reaction has been modest but as investors ponder a future of less frequent and less detailed policy communication from the Fed, long rates and spreads could both move higher.  

Except for real estate and large value stocks, equities took a breather in July after a stellar 2Q¹. Stocks in Semiconductors and Capital Goods, two industry groups at the heart of the AI/Data Center narrative, saw the sharpest declines¹. The former group was particularly hard hit from profit-taking, with many names slumping 20% - 50% from their highs after surging the prior quarter¹. The Large Value benchmark was spared to some degree by having a smaller aggregate weight in the key AI exposed groups, while the Small Cap benchmark saw larger declines in some of the more speculative names and comparatively less liquidity than in the large cap space¹. Broad large cap benchmarks, the Bloomberg 1000 and Bloomberg World Ex-US, saw modest overall declines with outperformance by non-US equities helped by lower overall exposure to the AI/Data Center trade¹. Roughly half-way through second quarter earnings season the results are exceptionally strong with both sales and earnings surprisingly positive, the latter by a healthy percentage on the back of rising margins¹. The Bloomberg 1000 Index is on pace to deliver 40%+ EPS growth in 2Q and with estimates continuing to rise calendar 2026 EPS growth is tracking at +27% YoY¹. For the S&P 500, 2Q EPS growth looks to be 33%+ which, other than coming out of the 2008 Financial Crisis and the rebound from Covid lockdowns, is the strongest quarterly growth rate in 30 years per Deutsche Bank¹. 

On the economic front, data has been steady with a modest bias to the upside. Initial Jobless Claims eased steadily in July with the 4-Week moving averaging falling to 202k on July 25^th from 222k on June 27^th1. That bodes well for the July employment report scheduled for release on August 7^th with consensus expecting an 80k increase in non-farm payrolls and unchanged unemployment rate at 4.2%¹. Real Average Weekly Earnings returned to positive territory in June with the -0.4% MoM decline in CPI¹. Both CPI and PPI data came in lighter than expected for June¹. CPI All-items and Core CPI eased to 3.5% YoY and 2.6% from 4.2% and 2.9%, respectively¹. Likewise, the Core PCE Index fell to 3.3% YoY, in line with expectations, down from 3.4% in May¹.  

The initial read on GDP showed a slowdown to a 1.5% annualized rate in 2Q from 2.1%¹. And the details offer one of the big question marks regarding the breadth of economic activity. Personal Consumption showed respectable 2.1% growth, largely offset by negative impacts from Net Exports (-1.0%) and Private Inventories (-0.7%)¹. Non-residential Fixed Investment added 1.2% (80% of total) to 2Q GDP growth, with the majority coming from Information Processing and Industrial Equipment, Software and R&D¹. For those keeping score at home, those categories essentially reflect AI/Data Center investment. The concern is that any slowdown in the AI/Data Center buildout -and there are signs that projects are not moving forward as quickly as expected at the start of the year- without a corresponding acceleration elsewhere could put a serious dent in the economy’s growth narrative.  

Between the World Cup, which was a solid success for North America as host and gave consumer spending a boost in July, the Semiconductor meltdown and the Iran Yo-Yo, investors spent little time in July on the mid-term elections. We think that comes back into focus in 3Q as campaign battles heat up with control of Congress on the line.  

[1] Source: Bloomberg