Weekly stock market update | Edward Jones

Five Turning Points & Their Implications

Key points:

• With inflation moving in the right direction, Fed officials are now more sensitive to downside risks to the labour market. The unexpected jump in July’s U.S. unemployment rate likely cements expectations for a September rate cut, potentially followed by one or two more cuts later in the year.
• Growth concerns are leading markets to price in a more aggressive easing cycle, driving a sharp rally in bond prices and a drop in yields. Now may be a good time for investors to take note of the reinvestment risk of having an overweight allocation to GICs and other cash investments during a period of falling rates.
• The U.S. tech giants reported strong growth, but that wasn’t enough to push prices higher, as the bar of expectations was high. While we navigate this risk-off phase, defensive sectors that tend to move inversely with bond yields could provide portfolio stability. We expect a broadening in market leadership ahead, highlighting the importance of diversification.
• While short-term pullbacks are uncomfortable, we do not expect any change to the relatively positive outlook. Inflation is moving closer to target, providing breathing room for central banks to ease; the economy continues to expand but at a slowing pace; productivity is on the upswing; and corporate earnings are rising. We would use pullbacks as opportunities to rebalance, diversify, and deploy fresh capital.

The typical summer lull was nowhere to be found in the markets last week. The final week of July was a whirlwind, filled with a flurry of earnings reports, three central-bank meetings, and key labour-market data. At first glance the abundance of datapoints suggested several crosscurrents. The Fed continued to hold rates steady even as Chair Powell recognized growing risks to the labour market. Corporate earnings are exceeding estimates, yet stocks have declined since the start of the second-quarter earnings season. Concerns about the growth outlook drove a U-turn in the recent rotation into cyclicals and small-cap stocks, while the artificial intelligence (AI) darlings experienced their biggest pullback this year¹.

Looking through the noise, we see several turning points in

1. Fed policy;
2. The labour market;
3. The yield curve;
4. Market leadership; and
5. Volatility.

These factors will likely define performance in the months and quarters ahead. Here is our take:

1) Fed policy: The start of an easing cycle is now in sight as focus shifts to jobs

After the most aggressive tightening cycle in 40 years and the second-longest pause in history with rates in restrictive territory (371 days since the last hike vs. 445 days in 2006-2007), last week the Fed sent the clearest sign yet that a new easing cycle might be around the corner¹. Over the past two-and-a-half years, inflation has been solely front and centre guiding policy. But as the Fed gets closer to achieving the first part of its mandate — stable prices — it is becoming more attuned to the second — maximum employment.

The Fed left its policy rate unchanged last week at 5.25% – 5.50%, as was expected, but it tweaked its statement to reflect the growing chance of a September rate cut. Chair Powell, in his press conference later, confirmed this possibility, saying, “The job is not done on inflation. Nonetheless, we can afford to begin to dial back the restriction in the policy rate.” With additional confidence that inflation is moving in the right direction, Fed officials have become more sensitive to downside risks to the labour market, which is why we think they will cut interest rates two or possibly three times this year instead of just the one that they projected back in June. Since June, inflation has fallen below the Fed’s 2.8% year-end projection, and the unemployment rate has now jumped above its 4.0% forecast¹.

The key takeaway, in our view, is that the labour data may play as big a role in shaping what comes next from the Fed and BOC as the inflation data, or bigger.