Monthly Update
The stock market continued on with its monthly winning streak for the fourth month in August, with particular catch up from the value and small cap world. While the S&P 500 rallied by 1.9%1, the small cap Russell 2000 charged ahead by 7%2 as hopes for Fed rate cuts helped this group of stocks that are highly sensitive to the cost of capital. The tech heavy NASDAQ was higher by 1.6%3 on the month. International bourses were up as well with the Euro STOXX 600 index higher by .7%4, the Nikkei up by 4%5 and the Hang Seng bouncing by 1.2%6, to name a few. Looking at the iShares MSCI ex US stock index, it was up by 4.1%7, pushing on with its outperformance relative to US stocks after many years of underperformance.
As stated, the market is celebrating the high likelihood of a September 17th rate cut by the Federal Reserve. I say that the likelihood is ‘high’ because Jay Powell basically told us so at his speech in Jackson Hole when he highlighted the greater downside risk to the labor market than there is upside risk to inflation, in his opinion. In response, we saw a drop of 34 basis points in the 2 yr Treasury yield, the part of the yield curve that is very sensitive to expectations of Fed policy. The 10 yr yield though is not as convinced that rate cuts are necessary and are also being kept up by the global rise in long-term interest rates. The 10-yr yield fell 15 basis points to 4.23%8 but the 30 yr yield actually rose 3 basis points to 4.93%9.
Rising long-term interest rates have been a global phenomenon. The Japanese JGB 30-year yield is higher by almost 90 basis points this year, 10 basis points in August alone and at the highest level since this maturity was first introduced in 1999. The French 30-year Oat yield jumped 29 basis points in August to 4.42%10, a 14 year high even with 200 basis points of European Central Bank rate cuts over the past year. The UK gilt yield is at a level last seen in 1998, up by 22 basis points in the month even with the Bank of England also cutting interest rates, albeit at a slower pace than the ECB. The more fiscally prudent German sovereign bond market has sold off too with the 30-year bund yield up by 16 basis points to a 14 year high. Mounting worries about growing debts and deficits I believe are the main reason for this rise as investors are becoming more averse to lending money for such long-term maturities to these countries, among others. With Japan specifically, they have an inflation challenge and are instead raising interest rates.
We watch this situation closely because after a 40-year bond bull market, market participants have pushed back against taking on too much duration risk. This is important because it implies that central banks have less influence over the entire yield curve and can really only control short term rates. In the US this is very relevant because the 30-year mortgage rate is priced off the 10 year Treasury yield.
The GenAI massive spending theme continued to be a big focus of investors but questions resurfaced on the slow take up from a user standpoint with regards to integrating it into one’s business. In July, MIT released a paper titled “The GenAi Divide, State of AI in Business 2025.” The conclusion, “Despite $30-40 billion in enterprise investment into GenAI, this report uncovers a surprising result in that 95% of organizations are getting zero return. The outcomes are so starkly divided across both buyers (enterprises, mid-market, SMBs) and builders (startups, vendors, consultancies) that we call it the GenAI Divide. Just 5% of integrated AI pilots are extracting millions in value, while the vast majority remain stuck with no measurable P&L impact. This divide does not seem to be driven by model quality or regulation, but seems to be determined by approach.”
I would assume that in time companies will do a better job of using the tools of GenAI, but I bring this up because the AI tech trade has become enormous to the point where the Mag 7 stocks, which also includes a non-AI tech stock, Tesla, make up about 35%11 of the S&P 500. Add in the remaining top three stocks and the big ten are now 40%12 of the S&P 500, a level of concentration that exceeds figures I’ve seen over the past 45 years. Concentration is fine as long as these stocks keep generating healthy earnings and higher multiples but once that growth slows, as it will, its impact on this index will be notable. It is why exposure to other parts of the equity market, not just in the US but also globally, we believe is very important.
Important economic and market news came out at the very end of August when a federal appeals court affirmed a prior court’s decision (the US Court of International Trade) that the Presidential use of the International Emergency Economic Powers Act to implement tariffs was unconstitutional. This case specifically relates to the 10%13 base line reciprocal tariffs in addition to some other tariffs on Canada, Mexico and China. The steel and aluminum tariffs, along with some others, are not affected as other Congressional sectional statutes were used for that.
As the appeals court gave the administration until October 14th to appeal its decision to the Supreme Court and it could take the Supreme Court into the Spring before ruling, the business uncertainty with these tariffs will continue and thus it’s too early for relief for those paying the tariffs. While the US government is bringing in more revenue from the tariffs, most comes from the US private sector, both businesses and households. I’ve seen estimates that exporters to the US are eating between 20% and 30%14 of the tariff via lower prices.
The US economy remains very mixed and uneven. First half 2025 GDP growth averaged 1.4%15 when we smooth out the impact of tariffs on the timing of shipments, both imports and exports. Massive spending on GenAI has been a major boost to economic activity, both on the tech and machinery side but also the construction part of these facilities. Also, upper income spending has been steady as has large amounts of government spending. On the other hand, weaknesses continue to be seen in housing, manufacturing, lower to middle income spending, global trade and CapEx spending ex AI. With regards to the labor market, it remains mixed too as the pace of hirings has slowed but the rate of firings remains muted.
On the inflation side, in August we saw the July stats, and the consumer price index was higher by 2.7% headline and 3.1% ex food and energy16. The PCE, which the Fed most focuses on, saw a core rate higher by 2.9% and a headline increase of 2.6%17. All still above the seemingly elusive 2% that the Fed has been targeting on a sustainable basis and thus begs the question as to how many rate cuts from here will we actually see. What will hold more weight for the committee, the labor market or inflation? For now, it seems like the former but elevated levels of the latter will limit the amount of rate cuts we’re likely to get I believe.
Conclusion
As always the case, a lot of moving parts here to the macro environment that directly impacts the company and household at the micro level. I think the biggest takeaway is that longer term interest rates are going to remain elevated even with central bank rate cuts. The GenAI tech trade has been tremendous as has its impact on the US economy, and globally too. But do the stocks already reflect a lot of optimism and will the returns on this investment be worth all the spend and what happens if too much spend is taking place like seen with fiber optics in the late 1990’s and we get overcapacity? What’s the tariff landscape going to look like at the end of the day? Either way, we’ll still be left with a bunch of them as the administration has other tariff tools to use to replace some of those struck down. Is the big outperformance in international markets going to be fleeting or something longer lasting and how will the direction of the US dollar flow into this? These are all the things we are constantly thinking about and trying to integrate into our investment process.
Either way, and something I say each and every letter, whatever comes our way it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the market. Time horizon is always crucial and is always the best friend of any investor.
Disclaimer
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