The start of the second half of the year mirrored the end of the first, with investors flocking to mega-cap technology stocks while the rest of the market lagged. Microsoft, Apple, Amazon, and Tesla all saw gains exceeding 2%, yet broader market indices like the equally weighted S&P 500 and the Russell 2000 small-cap index fell by 0.8%. This disparity in market breadth is concerning, though not expected to persist through the summer months. Weaker-than-expected economic data, which is anticipated, will likely bolster the perceived safety of the technology sector in the near term.

Economic Weakness and Market Response

Recent economic reports highlighted weakness in construction spending and manufacturing. Construction spending dipped by 0.1% in May, contrary to expectations of a 0.2% rise, though a revision showed April’s 0.1% decline turned into a 0.3% increase. Over the past year, construction spending has grown by a robust 6.4%. In manufacturing, the ISM purchasing managers index (PMI) fell to 48.5 in June, marking the third consecutive month below 50, indicating contraction. Despite some improvement in new orders, production remains stagnant. The silver lining is the sub-index for prices paid, which dropped to 52.1, suggesting the slowest cost increase for manufacturers this year.

Comparing Economic Surveys

The ISM survey’s weakness contrasts with the S&P Global PMI, which has been above 50 for five of the past six months, albeit with weak growth. Notably, the S&P Global survey covers over 1,300 companies compared to ISM’s 600, providing a broader view of economic conditions. Despite these surveys indicating varying levels of strength, both show slowing price inflation, a positive sign for disinflation efforts.

Federal Reserve and Inflation Control

Federal Reserve Chairman Jerome Powell recently acknowledged that the economy is “getting back on a disinflationary path,” citing the core Personal Consumption Expenditures (PCE) price index falling to a three-year low of 2.6%. This recognition drove bond yields lower and pushed stocks to record highs, with the S&P 500 surpassing 5,500 and the Nasdaq Composite climbing above 18,000. The market rally broadened, with nearly all S&P 500 sectors seeing gains.

Despite an increase in job openings reported in the latest Job Openings and Labor Turnover Survey (JOLTS), the balance between supply and demand for workers has improved. Job openings rose to 8.14 million, but the previous month’s figures were revised lower. Importantly, the number of job openings per unemployed worker remained at 1.2, the lowest since June 2021. This balance suggests that the risks between rising inflation and unemployment are now more balanced, hinting at potential policy actions if labor market weakness continues.

Future Outlook and Policy Implications

Powell’s insistence that the Fed can afford to take its time due to the strength of the U.S. economy and labor market is contentious. Many labor market indicators are lagging, meaning waiting for the unemployment rate to rise above 4% could lead to an unnecessary economic slowdown or recession. Changes in monetary policy have a delayed impact, typically taking 6-12 months to fully affect the economy. Thus, waiting until core inflation hits 2% before easing policy could stall the economy.

With leading economic indicators suggesting slower growth and continued disinflation, now is the time to begin normalizing policy. While delaying rate cuts until the September 3 meeting may not be harmful, any further delay risks repeating past mistakes. The balance between maintaining growth and controlling inflation will be crucial as we move forward.

Market Expectations and Consumer Spending

Weaker-than-expected economic data will likely persist through the summer, raising concerns about near-term growth but also reinforcing disinflation. The Atlanta Fed’s GDPNow model recently lowered its expected growth rate for the second quarter from 2.2% to 1.7%, and further softness is expected in upcoming jobs reports. This data is essential to convincing Fed officials to shift to a neutral interest-rate policy.

Despite these concerns, consumer spending remains resilient. The rate of inflation-adjusted consumer spending growth over the past year increased by 2.4%, supporting long-term economic growth. As consumer spending accounts for about 70% of economic activity, maintaining this rate is crucial for economic stability.

Conclusion

The dynamics between mega-cap technology stocks, broader market performance, and economic indicators highlight the complex interplay between market sentiment and economic reality. The Federal Reserve’s actions in response to disinflation and labor market conditions will be pivotal in shaping the economic landscape for the remainder of the year. Investors should brace for potential volatility but remain optimistic about the underlying strength of the economy and the market’s ability to adapt.