Equity Markets Chill As The Economy Softens

The equity market ended the week on a sour note. For the Friday session alone, the Dow Jones Average fell more than -370 points (-0.93%), the Nasdaq nearly -150 (-0.81%), while the S&P500 lost -40 points (-0.71%). The standout number in the table below is the performance of the Russell 2000 as market sentiment shifted toward smaller cap stocks and away from the mega-cap tech stocks that have held so much of the spotlight. The Russell 2000 was flat (0.0%) for the year two weeks ago (week ended July 5^th). This week’s gain adds to last week’s +6.00% move. However, it should also me noted that the Russell 2000 peaked on Tuesday (July 16^th) at 2263.67 and gave back -3.50% through Friday’s close. Just like the large caps, the small caps are not immune from downside volatility.

Meanwhile, the previously hot Nasdaq (tech) and the S&P500 (Magnificent 7) cooled off this week (-3.65% and -1.97% respectively). The next table shows the results for each of the Magnificent 7 from their peak July price to the close of business on Friday, July 19^th. Surely, a correction was due. The question is whether it is over or if the downdraft continues.

Data vs. Sentiment

Incoming data continue to raise concerns that the equity markets’ assumption of either a “soft-landing” or “no landing” at all are out of touch with economic reality. The Conference Board’s Leading Economic Indicators (LEI) for June showed up negative again. Economist David Rosenberg noted that when there are long periods of negative downdrafts in the LEI, they are always associated with Recessions. (That’s, of course, why they are called “Leading” Indicators!) One can clearly see that in the chart below.

Jobs and The Fed

The job market is becoming a concern. The chart shows a disturbing rise in both Initial Jobless Claims and Continuing Claims. The Fed’s tight monetary policy is taking a toll. One upcoming issue will be the long lag between a change (loosening) in monetary policy and its impact on the economy. The two rate cuts expected this year (September and December) won’t impact the economy Q3 of Q4 of 2025. In addition, two rate cuts still leaves policy in ultra-restrictive mode.

We are forecasting significantly more deterioration in the jobs market over the next several quarters. We’ve already seen a significant jump in job cuts in the construction sector, and hiring intentions are trending down (see chart).

Housing

As discussed in prior blogs, housing is an important contributor to GDP. Housing is the most sensitive sector to interest rates. So, it isn’t a surprise that the chart for ‘Buying Conditions for Houses’ is at a low point. A resulting consequence is that sales of large household goods (furniture and major appliances) are also in decline. We expect a soft GDP report at month’s end, and likely negative prints in Q3 and Q4.

Inflation

The recent deflation print in the CPI and the ongoing fall in the prices of goods bodes well for the inflation picture going forward. The worrisome wage/price spiral never developed, and wage growth has moderated to the 3% level. In addition, with multi-family housing completions at record levels, rent inflation will soon dissipate with the possibility of rent deflation next year.

Final Thoughts

Equities have soured over the past two weeks and we wonder if there will be more giveback in the near-term.

We continue to see the beginnings of erosion in the job market and forecast a rising U3 Unemployment Rate and the uptrend in layoffs to continue.

Interest rates have already played havoc with the housing market. Home sales have fallen and won’t likely rise until interest rates fall back to where mortgage rates are in the 4% range.

Our base case forecast continues to be for an upcoming period of price deflation. Once again, in the normal course of events, Deflation and Recession go hand-in-hand.

To end on a positive note, we expect inflation to become a non-issue by year’s end!

(Joshua Barone and Eugene Hoover contributed to this blog)