July brought a cooling breeze to the red-hot rally that defined the first half of 2024. The S&P 500’s modest 1 percent gain for the month was in stark contrast to its blistering 14.5 percent advance in the first six months, when it put roughly three dozen record highs. This slowdown was largely due to a rotation from large-cap stocks to small-caps, blunting the market’s previous momentum.

The Dow Jones Industrial Average outperformed its peers with a 4 percent gain, while the tech-heavy Nasdaq Composite fell slightly. This difference highlighted this month’s key theme: a shift from AI-powered tech giants to lagging sectors such as industrials and to smaller businesses.

The actions of the Federal Reserve played a critical role in shaping market sentiment. While the decision to keep interest rates steady at the July 31 meeting was long-awaited, investors scrutinized Fed Chairman Jerome Powell’s press conference for future policy clues. Encouraging inflation data, along with a cooling but still resilient labor market, fueled expectations of potential interest rate cuts as early as September. The PCE price index rose 2.5 percent from a year earlier in June, inching closer to the Fed’s 2 percent target, bolstering hopes of a “soft landing” scenario.

Markets reacted strongly in the days following the July Fed meeting. The Dow Jones Industrial Average fell more than 600 points in a single day, reflecting investor disappointment that the Fed had not moved more decisively toward rate cuts. This negative sentiment was exacerbated by a weaker-than-expected jobs report on August 2, which showed just 114,000 new jobs in July and the unemployment rate ticking up to 4.3 percent. While supporting the case for future interest rate cuts, these data also fueled fears of a potential economic downturn.

The market’s volatile reaction underscored the delicate balance the Fed must strike. While lower interest rates can stimulate growth, premature cuts risk a resumption of inflation. Equity traders, who had priced in rate cuts, were forced to recalibrate their expectations, leading to the sharp sell-off.

Labor market data earlier in July suggested a gradual normalization. The Job Openings and Labor Turnover Summary (JOLTS) report showed job openings were steady at 8.2 million in June, with the unemployment rate at 4.1 percent, supporting hopes of a “soft landing.”

The expectation of interest rate cuts triggered a remarkable market rotation. The Russell 2000 small-cap index is up 11 percent so far this year and outperformed the Nasdaq Composite by 12.8 percentage points in July — its biggest monthly advance since February 2001. That rotation came at the expense of large-cap technology stocks. Microsoft, Apple and Nvidia faced increased scrutiny and profit-taking, with Nvidia shares falling 7 percent in a single day.

Despite this volatility, large companies across sectors remain fundamentally strong, with robust balance sheets and positive cash flows. The market’s reaction reflects changing economic expectations rather than a change in the long-term outlook of these companies.

Not all sectors benefited equally from this rotation. Consumer staples, usually a haven during volatility, unexpectedly underperformed other defensive sectors. Nestlé and Kimberly-Clark reported mixed earnings, highlighting concerns about changing consumer behavior in the U.S. and increased marketing activity, particularly among low-income demographics.

July also highlighted the market’s vulnerability to technical disruptions. A significant bug in CrowdStrike’s cybersecurity software caused widespread disruption, affecting millions of Microsoft Windows devices globally and disrupting operations worldwide. That incident led to a sharp 11 percent drop in CrowdStrike’s stock price and rippled through the technology sector, serving as a reminder of the interconnectedness of the world and the potential for localized technical problems to have far-reaching market effects.

Looking ahead, investors should not be overly reactionary to the daily trading activity. The lessons of history remind us of the importance of maintaining a diversified, long-term investment strategy. While the market’s recent volatility may seem worrisome, it’s important to see the forest through the trees. Just as investors may have overreacted to the AI ​​hype earlier in the year, there is a risk of excessive pessimism during market downturns.

The US economy is showing resilience, with GDP growth at an annual rate of 2.4 percent in the second quarter. Consumer confidence, although falling slightly, remains strong at 117.0 in July. These economic strengths, combined with potential Fed policy changes, should provide support for stocks in the coming months.

July 2024 reminded us that markets are multifaceted. While headline numbers suggested a quiet month, significant rotations occurred beneath the surface. Going forward, maintaining conviction in high-quality companies across sectors will be key to navigating market fluctuations.

William Rutherford is the founder and portfolio manager of Portland-based Rutherford Investment Management. Contact him at 888-755-6546 or (email protected). Information contained herein comes from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investing involves risk and can lead to losses.

The views, beliefs and opinions expressed in the preceding commentary are those of the author and do not necessarily reflect the views, beliefs and opinions of the Daily Journal of Commerce or its editors. Neither the author nor DJC guarantees the accuracy or completeness of any information published herein.