Highlights for This Week Include:

• Current economic readings remain consistent with further economic growth and lower inflation. However, leading economic indicators continue to signal slower growth ahead.
• The July FOMC meeting minutes confirmed that the process of lowering interest rates is likely to begin in September due to lower inflation risks and higher labor market risks.
• The stock market’s strong rebound from the early August low is an encouraging signal, with the S&P 500 close to retesting the July all-time high. Given the still positive economic and profit backdrop, this suggests the current correction is a normal pullback within an ongoing bull market. See below for details.

Evidence of Economic Resilience

The rebound in stock prices coincides with economic readings that are consistent with further economic growth. Signaling a resilient consumer, retail sales jumped 1.0% in July, the most since January 2023, and much stronger than the consensus estimate of 0.3%. The leading contributor was vehicle sales, but most other major retail categories posted gains. On a y/y trend basis, retail sales increased 2.4%. While it has come down substantially from earlier in this cycle, it is now running close to pre-pandemic rates.

Further spending growth hinges on labor market strength, especially since excess savings from the pandemic has been exhausted. Slower job creation and some pickup in the unemployment rate suggests a slower pace of consumer spending in the coming months.

In a positive sign for future consumption, consumer attitudes improved slightly in August. The Michigan Consumer Sentiment Index saw its first increase since March, led by a rise in consumer expectations to their best level in four months, with the outlook for both personal finances and the economy strengthening.

However, Signs of Slower Economic Growth Ahead

The Philly Fed state coincident indexes, designed to summarize current economic conditions in a single statistic, showed economic growth narrowed across states in July, a sign that broad economic momentum is slowing. The coincident indexes increased in 26 states, decreased in 17, and were stable in seven.

The national coincident index, however, based on the same methodology as the state indexes, rose 0.1%. It suggests that growth in larger states is driving the economy, while the weakness is concentrated in smaller states. Nevertheless, the latest gain in the national index was the smallest in this cycle and one more confirmation that growth is slowing.

The Conference Board’s Leading Economic Index (LEI) fell in July and continues to point to slower growth ahead. The LEI peaked in December 2021 and has declined in all but two months since then. Defying the historical record, this long period of drawdowns has not led to a recession. Economic weakness has been concentrated in manufacturing and construction, which are heavily represented in the LEI components. Other parts of the economy, however, such as consumer spending and services activity more broadly, have held up well, benefitting from fiscal stimulus and excess savings from the pandemic.

The pace of decline in the LEI has eased since the spring of 2023, a sign of improvement in the economic outlook, despite some persistent headwinds. Given the unique aspects of the post-pandemic economy, the Conference Board is projecting slower growth, but no recession, in the second half of 2024.

An Update on the Federal Reserve and Outlook for Interest Rates

The minutes from the July FOMC meeting confirmed that a September rate cut was likely even before recent signs of labor market weakness. Prior to the release of the weak July jobs report, the “vast majority” of committee members already held the view that if data continue to come in as expected, the FOMC will be on track to begin easing at the next meeting. “Several” committee members even saw a case for cutting rates in July. On the balance of risks, a “majority” thought “risks to the employment goal had increased,” and “many” thought inflation risks had decreased.

Thoughts on Stock Market Dynamics and Earnings Season

The stock market’s strong rebound from the early August low is an encouraging signal, with the S&P 500 now close to its all-time high. Almost every sector, except for Energy, has shown signs of recovery from the August low. Given the still positive economic backdrop with lower inflation noted above, this suggests the current correction is a normal pullback within an ongoing bull market.

Corporate profits continue to come in better than expected, supported by a healthy second quarter economic backdrop. Second quarter earnings reporting season is winding down, with about 90% of S&P 500 companies having reported. Second quarter expectations are now for earnings to grow by 11% y/y. The better-thanexpected earnings growth is similar to recent quarterly results. Earnings are beating estimates by 5.5%, with 73% of companies topping projections. Information Technology and Communication Services are delivering the fastest earnings growth at the sector level, led by the mega-cap tech stocks.

Analysts are now expecting third quarter earnings growth of 6.0%, with recent history suggesting that earnings will come in higher. Corporate fundamentals also suggest a recession is not imminent. Historically, profit margins have typically begun contracting prior to the start of recessions. Today, in contrast, both S&P 500 and economy-wide national income and product accounts (NIPA) profit margins have been rising from their 2023 trough, implying less impetus for companies to pull back on hiring or begin layoffs.