Why August’s Rally Reveals More Than Most Market Observers Realize
August delivered something many seasoned investors thought was impossible four months ago: the S&P 500’s 20th record high of the year. But here’s what caught my attention—this wasn’t just another tech-driven surge. We witnessed something far more telling about the underlying health of our markets and economy.
The Broadening That Changes Everything
For the better part of 2024, we’ve watched a narrow group of mega-cap technology stocks carry the entire market on their shoulders. August flipped that script entirely. The equal-weight S&P 500 hit new all-time highs, signaling that the “average” large-cap stock finally joined the party. This isn’t just a statistical curiosity—it’s a fundamental shift that speaks volumes about investor confidence spreading beyond the usual suspects.
I’ve been watching markets long enough to know that sustainable bull runs require broad participation. When Health Care emerges as the month’s top performer while Utilities trail (a complete reversal from July), you’re seeing real rotation based on changing economic expectations. This isn’t momentum chasing; it’s smart money repositioning for what comes next.
The small-cap revival particularly caught my eye. The S&P 600 Small Cap Index surged roughly 7%, marking its best month of outperformance over the S&P 500 in over a year. Many hedge funds were caught short small caps—literally. According to CFTC data, non-commercial short positions in the Russell 2000 recently hit their highest levels since 2022. The resulting short-covering rally provided additional fuel, but the underlying fundamentals tell a more compelling story.
Reading Between the Fed’s Lines
Jerome Powell’s Jackson Hole speech marked a pivotal moment that many investors underappreciated. His shift from singular focus on inflation to balancing the dual mandate of employment and price stability represents the most significant change in Fed messaging since the post-COVID era began.
Here’s my take: Powell’s acknowledgment that “policy in restrictive territory” might need adjustment reveals a Fed increasingly concerned about labor market softening. The unemployment rate edged to 4.2% in July—still historically low, but the trajectory matters more than the level. With net immigration near zero, our labor supply constraints create a unique dynamic where unemployment won’t spike dramatically even as job demand slows.
This creates an interesting paradox. Lower labor supply should theoretically support wages and potentially inflation, but it also constrains economic growth. The productivity question becomes critical—can AI and technological advancement offset this demographic headwind? MIT’s recent finding that 95% of AI pilot programs deliver no measurable return suggests we might be waiting longer for that productivity boost than many expect.
Inflation’s Stubborn Reality Check
While markets celebrated relatively stable CPI data at 2.7%, I’m watching the details more closely. Core inflation’s uptick to 3.1% tells a different story than the headline numbers suggest. The price increases in furniture and other imported goods could signal tariffs beginning to filter through the economy, though it’s still early to draw definitive conclusions.
This presents a fascinating policy dilemma. One camp argues tariffs create only one-time price adjustments and shouldn’t influence monetary policy. The other warns we haven’t seen the full impact yet. I lean toward caution here. With goods like furniture—where the U.S. leads global imports while China dominates exports—we’re seeing exactly what economic theory predicts when trade barriers rise.
The Fed’s challenge intensifies when you consider labor market dynamics. Certain industries—construction, hospitality, agriculture—rely heavily on immigration to fill workforce gaps. Restricted labor supply in these sectors could drive wage inflation even as overall job growth slows. It’s a recipe for persistent services inflation that could complicate the Fed’s rate-cutting plans.
The Earnings Reality Check
Let me address the elephant in the room: earnings quality. Q2 earnings per share growth for the S&P 500 reached nearly 12%—more than double initial expectations. Over 80% of companies beat bottom-line estimates, with 50 issuing positive guidance. These aren’t just numbers; they reflect real business fundamentals that justify market valuations.
The earnings revision breadth for the S&P 500 climbed to its highest level since August 2021. This metric—net upward revisions minus downward revisions—strongly correlates with future market performance. When I see this kind of broad-based earnings momentum, it pushes back against bubble narratives that focus solely on valuations.
Even NVIDIA’s “disappointing” results need context. Yes, the AI darling saw its slowest revenue growth in years, but we’re talking about high double-digit growth from a company carrying 8% of the S&P 500’s weight. The market’s measured response—brief selling followed by recovery—demonstrates maturity in how investors process information.
Geopolitical Noise Versus Market Signal
One of the most telling aspects of August was how markets shrugged off potential volatility triggers. From trade tensions to the attempted firing of Fed Governor Lisa Cook, any of these events could have sparked significant turbulence. Instead, we saw the VIX trade at 52-week lows.
This resilience reveals something important about current investor psychology. Either markets have already priced in political uncertainty, or investors increasingly separate policy noise from economic fundamentals. The dollar’s weakness to 52-week lows while Treasury yields remain relatively stable suggests the latter.
Here’s what I find particularly interesting: for all the talk about declining U.S. exceptionalism, our equity markets continue outperforming globally. Yes, the dollar has weakened, but that follows years of strength and could actually benefit U.S. exporters and multinational corporations.
September’s Challenge and October’s Promise
As I write this, we’re entering September with the market at short-term overbought levels and little margin for error. September’s historical reputation for turbulence is well-earned, but context matters. When markets trend higher into September, seasonal weakness often fails to materialize.
The key variables I’m watching: continued earnings growth, Federal Reserve policy clarity, and whether the recent broadening of market leadership sustains. If we do see a September pullback, October historically provides strong tailwinds—potentially amplified by an actual rate cut rather than just expectations.
The Bottom Line
August’s rally wasn’t just about prices going up; it revealed fundamental strength in the U.S. economy and corporate sector that many observers missed. The broadening of market leadership, combined with robust earnings revisions and Fed policy flexibility, creates a foundation for continued gains.
Yes, inflation risks remain, and seasonal headwinds loom. But when I look at the totality of evidence—from small-cap revival to earnings quality to market resilience in the face of uncertainty—I see an economy and market structure capable of navigating these challenges.
The real question isn’t whether we’ll see volatility ahead—we will. It’s whether investors can maintain perspective on the underlying fundamentals that made August’s broad-based rally possible in the first place. Based on what I’m seeing, that foundation remains remarkably solid.
