Here Comes August, Buckle Up
We wish we knew why, but August is a month that tends to have a lot of out-of-the-blue scary events pop up along with a good deal of market volatility. Well, just one trading day into August and the pattern continues. A weak jobs report piled on some negative tariff news to send the S&P 500 down 1.6% on Friday, not a horrible day but its worst day since May 21.
Who could forget last August? Stocks fell more than 1% on the first Thursday and Friday of the month, and then on Sunday, August 4, we went to sleep knowing that Japan was crashing (having its worst day since the Crash of 1987) and US futures were down huge as well. That Monday saw the VIX (a market-based measure of stock risk) spike to 50 and the S&P 500 fell 3% for one of its worst days in years.
After more selling into the middle of the week and incredible amounts of fear, stocks bottomed that Wednesday and actually finished up on the month. Still, if you were there you remember how frightening it was, and sure enough it happened in August.
There’s Something About August
Going back to 1990 when Iraq invaded Kuwait, August is notorious for big events and market weakness. 1997 had the Asian Contagion, 1998 the Russian Default, and 2010 the European Banking Crisis. The next year saw the first US debt downgrade and a near bear market in just a few days. 2015 had the first 1,000 Dow point drop ever after the surprise Chinese yuan devaluation. Then in 2022 Jerome Powell surprised markets in August by turning quite hawkish at the annual Jackson Hole Economic Symposium. All of these times saw big drops, proving once again there is something about August.
Buckle Up
By no means are we saying this bull market is over. We don’t think it is. But after a 28% rally off the April lows, we’d suggest being open to some potential volatility this August, as this is a month known for it.
Since 1950, August is the third worst month on average and in a post-election year only February is worse. No, we don’t suggest ever investing purely based on seasonality, but it is important to have a plan and we’d say planning for some August turbulence is the way to go.
Another reason to buckle up? August hasn’t been higher under a second term President in a post-election year back to when Eisenhower was in office. That’s down six times in a row.
There Is Good News
Let’s be clear, we still expect stocks to be higher by year-end than they are now. But that doesn’t mean we won’t have a few scary moments this August, so start preparing for them now. Why are we optimistic? Earnings are hitting record levels and profit margins are hitting new cycle highs. We’ve talked about these two things for years now and called them the dual tailwinds to this bull market and the good news is nothing has changed. If there is some August weakness use it as an opportunity to practice not getting pulled into any overhyped negative sentiment we may see (like many did successfully during the volatility earlier this year).
The Economy Is Currently Being Held Up By AI
This was a big week if you wanted to get a picture of the economy, inflation, and even policy (both monetary and tariffs). Here’s the big picture:
- The labor market is clearly slowing, despite a low headline unemployment rate of 4.2%.
- Soft payroll growth and easing wage growth means aggregate income growth is slowing.
- Inflation is stubbornly elevated, with disinflationary forces in shelter and travel offset by a tariff-related pickup in core goods prices and even food prices.
- As a result, wages are just about able to keep up with inflation, but not much more, and so real consumption has slowed significantly.
- Elevated inflation, driven by goods prices, is staying the Fed’s hand despite labor market weakness, and more tariffs on August 1st will not help.
- Elevated interest rates are hurting rate-sensitive areas of the economy like housing, which are now dragging on economic growth.
- The economy would be at stall speed, if not a recession, if not for the absolute boom in AI-related spending.
Let’s dig in.
The Labor Market Hits Stall Speed
The unemployment rate remains at a historically low level of 4.2% but that hides a lot of underlying weakness. The economy created 73,000 jobs in July. That may be just about enough to keep up with population growth since immigration has collapsed. The problem is that the prior two months were revised down by a whopping 258,000 jobs:
- May job growth was revised down from 144,000 to 19,000.
- June was revised from 147,000 to 14,000.
This brings the 3-month average to just 35,000, assuming we take the July number at face value. For perspective, the prior 3-month average (February–April) was 127,000, which was already a slowdown from the 2024 average of 168,000. Manufacturing has lost 37,000 jobs over the last 3 months. Liberation Day and associated tariff chaos clearly took a toll, along with elevated interest rates. What’s uncertain here is whether May–June was the worst of it, and things look better now because the administration has pulled back on tariff extremes.
Combine really soft payroll growth with easing wage growth and flattish hours worked, and we’re looking at softer aggregate income growth (total income growth across all workers in the economy). Over the last three months, aggregate income growth is running at a 4.5% annualized pace. That would be similar to what we saw pre-pandemic in 2018–19, but inflation was running below 2% at the time, whereas it’s running closer to 3% now.
Inflation Remains Stubbornly Elevated, Leaving the Fed With a Problem
Core inflation (excluding food and energy), as measured by the Federal Reserve’s (Fed) preferred personal consumption expenditures (PCE) index, rose at an annualized pace of 3.1% in June, and is up 2.6% over the last three months. Core PCE is up 2.8% over the last year, and the big picture here is that inflation remains stubbornly elevated over the Fed’s target of 2% and has moved sideways for about 14 months now.
The picture was quite different at the start of the year, when we expected inflation to head lower across the year, especially on the back of shelter disinflation. That’s actually happening, and in fact we’re even seeing lower prices for recreation services, hotels, and airfares—which also tells us spending in these areas is easing.
The problem is that all of this is being offset by a pickup in core goods inflation (things like furnishings, appliances, and recreational goods). Core goods prices rose at an annualized pace of almost 6% in June and are up 4% over the last three months. That is the fastest pace since March 2022, when we had the supply chain crisis. Outside of Covid, it is actually the fastest 3-month pace since 1991! Since the 1990s we have seen a continuous decline in core goods prices. as we got cheap goods on the back of globalization. The big break came after Covid when global supply chains broke, but the downtrend resumed in 2023–2024. Until now, that is, and this is where the tariffs are making their most direct impact.
Even beyond core goods, we’re seeing inflation in a couple of other key areas that matter to household wallets:
- Restaurant price inflation has been accelerating, running at an annualized pace of 4.6% over the last three months. That’s well above a “normal” pace of about 3%, which would be consistent with the Fed’s target of 2% inflation.
- Utilities prices (electricity and gas) are also surging, growing at an annualized pace of 12.5% over the last three months. The main reason is more artificial intelligence (AI)-related demand, while supply isn’t expanding at the same pace.
Consumer Spending Stalls
Lower aggregate income growth and higher inflation should translate to lower “real” spending (spending adjusted for inflation). And that’s exactly what we’re seeing. Real consumer spending grew at an annualized pace of just 0.9% in the first half of 2025. That’s well below the 2023–2024 pace of 3.1% (which is why GDP growth clocked in near 3% over the prior two years) and even the 2010-2019 pace of 2.4%.
A big reason sharply easing services spending, which matters because it makes up 45% of the economy. Services spending ran at a 0.9% annual pace in the first half, a sharp downshift from the 2023–2024 pace of 2.9% and even the 2010–2019 pace of 1.8%.
In short, consumers are just about able to keep up with inflation. But since wage growth is easing, we’re seeing a slowdown in real spending.
The Fed Stays on Pause, Buffeted by Opposing Forces
The labor market is clearly slowing, and that by itself ought to trigger interest rate cuts. Policy rates are certainly elevated at their current level of about 4.5%, especially since wage growth is near 3.5%. As we wrote in our Midyear Outlook 2025, as wage growth continues to soften, policy is getting tighter if the Fed doesn’t cut rates.
Here’s the Fed’s problem: stubbornly high inflation, even with the impact of tariffs only just starting to show up in the data.
The Fed took a pass on cutting rates at their July meeting because of this. Powell pointed out that they have two mandates: stable prices and maximum employment. They believe that the labor market is in good shape right now (at least before the most recent release) and the low unemployment rate is consistent with their mandate of maximum employment. However, they’re worried about inflation remaining elevated, and pass-through effects of tariffs, which they believe will take several months to show up. The White House also has a new tariff blitz as of August 1 (but they won’t go into effect until August 7).
Moreover, in his post-Fed meeting press conference, Powell noted that the economy isn’t performing as if restrictive rates are holding it back, and if anything, rates are only modestly restrictive. This implies they’re willing to wait longer to get more data, and even if they cut, it may not be by much.
It’ll be interesting to see how the July payroll data reshapes their thinking, but in all likelihood, we’ll probably get a better picture of the policy rate path only after the next one or two inflation reports. Markets were pricing in a 66% probability of a September rate cut before the Fed’s July meeting, but that dropped to 40% after Powell’s comments during the post-meeting press conference. However, the weak payroll data sent the probability of a September cut surging to over 80%. This is going to continue shifting over the next month, until we get clarity from the Fed.
Economic Growth Is Being Held Up by AI
Real GDP growth clocked in at a 3% annual pace in the second quarter, a sharp upswing from the 0.5% pullback in Q1. But that was on the back of trade volatility, as imports swung wildly up and down due to tariff front-running, along with inventories. Net exports (exports minus imports) dragged from GDP growth by 4.5%-points in Q1 and added 5%-points in Q2. Both were the largest ever on either side.
But the headline strength in Q2 GDP growth hides underlying weakness. “Real final sales,” which essentially measures consumer, business, and government spending and investment, rose 1.1% in Q2, slowing from an already below-trend pace of 1.5% in Q1—thus averaging 1.3% over the first half. For comparison, this measure rose at an annual pace of 3.2% in 2023–2024 and 2.5% in 2010–2019. There’s a real slowdown in place.
The big driver of the slowdown is consumer spending, as I discussed previously. And thanks to elevated rates, business investment (especially in structures) and residential investment (housing) are also a drag. Government spending is also slowing.
All of this by itself would have meant the economy stalled in the first half of 2025. However, there was a major factor pushing things the other way, and helping the economy avoid the precipice of a recession: AI spending, both on the hardware and software side.
- Equipment spending on computers and peripherals has been rising over the last two years but surged another 35% over the last six months (translating to an annualized pace of 83%!).
- Software spending rose at an annual pace of 6% in the first half.
AI spending contributed an average of 1.0%-point to GDP growth over the last two quarters. That’s more than the contribution of 0.6%-points from consumption, which makes up close to 70% of the economy.
Cash-rich tech companies are going on a capex spending spree, providing a crucial boost to the economy, and that’s not ending soon, based on recent tech company earnings calls. But it also hides the underlying weakness in the economy and makes the headline data look better than it is. When combined with tariff-related inflation in core goods, that’s pushing the Fed away from providing interest rate relief, which means rate-sensitive parts of the economy will continue to struggle.
There’s a reason we called our Midyear Outlook “Uncharted Waters.” It’s not that we saw a bad outcome ahead. To the contrary, we thought (and still believe) economic growth will be enough to support continued profit growth. But the economy is facing a lot of structural changes (including AI) and that makes the way ahead harder to see. As a result, the mood can change on a dime, as it did Friday (and could again). We can’t blame the calendar, but still, there is something about August.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Compliance Case # 8243727.1_080425_C
