I love watching the Olympics. I can’t get enough of seeing athletes’ dreams and hard work come to fruition. And hearing about their habits and practices during interviews are lessons for all aspects of life. But, for me, the Summer Olympics also has a dark side—a personal association related to markets. I can’t help but vividly remember what ensued just after the Olympics ended in 2008, and how much life changed in the summer of 2020. 

And here we are again. Market headlines like “Nasdaq sinks to lowest level” or “90% of stocks are down” are naturally igniting inherent risk sensors in our investing brains—“danger!” Then comes questions like “should I sell out of my portfolio now?”, or “are we heading for a recession?” And hindsight observations like “shoot, I should have trimmed gains when everything felt good.”

In short, it's beyond easy to let fear set in. Yes, the market dropped (-8.5% from peak of the S&P 500 on July 16 to the trough, so far, on August 5) and some moves from stock to stock may actually be warranted, but corrections are also normal. A correction is generally defined as a price decline of 10% or more—which seems to happen every 1-2 years. This chart shows annual returns and intra-year drops going back to 1974.

I had written in my mid-year outlook back in July that markets would likely experience a pullback in late summer, which has historically been the toughest market months, with low liquidity. And not because I expected a recession, but because they just happen, and it seemed like it was time.

Importantly though, we believe, the economy has not deteriorated to a level warranting major concern.

Let’s break down how we got here. One word – expectations. The recent pullback initially started in the most heavily owned stocks, after several of the largest 10 reported earnings that were disappointing relative to expectations. When valuations and expectations are high, the room for disappointment is vast, so not-good-enough news can prompt investors to sell and reprice stocks.

Then, after weaker-than-expected employment numbers on Friday, the market decline spread more broadly. As part of this, attention has been focused on the so-called "Sahm rule," which triggered after the 3-month moving average of the U.S. unemployment rate rose 0.5 percentage points (after rounding, because it was technically 0.49) above its lowest level during the previous 12 months. 

Let’s look at the unemployment rate a bit closer. The increase in unemployment has come not from heavy layoffs but from an increase in the labor participation rate, which has risen, according to the Bureau of Labor Statistics, from its lowest point of 60.1% (September 2020) to 62.7% (July 2024)--with a step change up since March 2023. And while job growth is slowing, it remains net positive.

What we’re also seeing  Household demand is still resilient. Consumer spending represents about 2/3 of the U.S. economy and real personal consumption was up 2.6% in July. Most recessions were preceded by at least 1 quarter of slow consumption growth. We’ve seen the opposite; from Q1 to Q2 2024, consumer consumption grew from 1.5% to 2.3% on an annualized basis, according to the Bureau of Economic Analysis. While sentiment data from Consumer Confidence and the University of Michigan shows that consumers are becoming more wary of economic conditions, this historically has been a counter-signal for the markets. And the Fed has all but baked in a rate cut next month, which should ease some fears from businesses and consumers.

Then there are earnings  Although some of the big firms missed expectations, broadly speaking earnings growth has been good. According to FactSet, with over 80% of S&P companies reporting, earnings growth is coming in at 12%, compared to the ~9% pre-season forecast. Furthermore, guidance is still largely positive. The percentage of companies issuing negative EPS guidance for Q3 2024 is 53% (39 out of 74), which is below both the 5-year average of 59% and the 10-year average of 63%.

In summary, we believe economic conditions don’t currently indicate a recession or a larger bear market, but rather a slowdown from historical levels. We also believe investors are collectively using their voice, telling the Fed that now is the time to cut rates. We saw something similar in 2018 when the S&P 500 corrected by more than 10% in December, followed by a rebound of more than 13% in Q1 2019, ahead of the Fed’s rate cut. I wouldn’t be surprised if the S&P falls to around 5,100 before bouncing back to end the year higher at around 5,800-5,900—after the Fed commits to a cut next month. It’d be an achievement the market worked hard for. In short, the recent market is enough to make us all uneasy, but we think, this time, it’s simply within normal expectations.