The Summer Lull

It is hard to believe that we are in August already. July proved to be an eventful month, marked by record-breaking temperatures and widespread forest fires that pushed Toronto’s air quality to among the worst in the world. Unfortunately, that volatility extended to financial markets as well. All three major US indices retreated for the month, with the Dow Jones pulling back 3.2%, the S&P500 down 0.1% and the tech-focused Nasdaq down 3.2% respectively1. The TSX, however, outperformed its US counterparts by gaining 1.1%, predominantly driven by energy and financials.

This pullback does not come as a surprise. We’ve alluded to the fact that a healthy market is not one that moves up linearly, and period breaks are healthy (and expected). As we wrote last month, the Nasdaq’s decline suggests investors may be rotating out of technology and AI-related stocks after more than two years of market leadership. Those fears now seem a bit overblown, as the sector posted two strong days in a row to start off this week.

It is also important to note that July and August are historically considered to be weaker months of the year, as lower trading volumes often accentuates the volatility. We believe that the summer doldrums are often the market's way of catching its breath before the next move.

We remain in the Green Zone across our longer-term indicators, but we do expect the markets to trade relatively sideways into early fall. Our portfolio had outperformed the markets year to date but pulled back more than the major indices in July, as several positions were affected by cautious investor sentiment despite strong earnings. In response, we began de-risking last week by raising cash and pivoting to defensive positions that can still participate in future upside.

Russ Visch, BMO’s Chief Technical Strategist, highlighted earlier this week:

“We italicize the word “ostensibly” since seasonality is about to become a solid headwind all the way out to October (August is the third weakest month of the year for the S&P 500 with an average return of 0.04% and only positive 54% of the time.) and we don’t believe the recent consolidative process qualifies as the correction that typically occurs ahead of the U.S. mid-term elections that we’ve discuss in recent reports.”

Barring unforeseen circumstances, we continue to maintain that the pullback should be short-lived (and seasonal) and still expect a strong finish to the calendar year. We plan to redeploy funds back into technology, small-to-mid caps, healthcare, and financials as prompted by our shorter-term charts.

Brent Joyce, BMO’s Chief Investment Strategist, succinctly summarizes in his commentary earlier this week:

“In many markets, including the S&P 500 and S&P/TSX indices, declines from their peaks are merely mild, low-single-digit percentages, which is consistent with a healthy test rather than a breakdown.

In some areas, the pullbacks represent constructive rotations between sectors; in others, they are important tests and displays of discipline. Elsewhere, they reflect a cleansing of over-exuberance. We don’t view July’s red ink as a harbinger of doom or the makings of a peak for this bull market. Rather, we see it as a pause that can refresh.”

 

Is the AI boom over?

As mentioned, July marked a retreat and a rotation away from technology and AI-driven stocks, and many are questioning if the gravy train has reached its destination. We believe this scrutiny is healthy for the sector, even before its recovery this week. Investors are becoming more disciplined and selective. Instead of mindlessly investing in everything AI-related, investors have moved past the initial enthusiasm and are focusing on how a specific company “roadmaps” its AI spending to profitability. After the recent round of earnings reports, the winners and losers are becoming increasingly apparent.

Brent Joyce seemingly echoed our stance that the AI space will continue to grow in his commentary:

“All of this is healthy. Stock and bond investors are asking the right questions and voting with their capital – exactly the type of discipline we want to see accompanying this fast-growing investment theme.”

 

Déjà vu

Raise your hand if you’ve heard this story before:

  • The US threatens to obliterate Iran
  • The US gives Iran their “last chance”, calls off attacks, claims progress on an agreement
  • Iran denies any talk
  • Cargo ships continue to be struck in the Strait of Hormuz
  • Rinse and repeat

This exact scenario played out this past weekend, and the narrative has been recycled for the last six months. The markets largely shrugged off the back and forth, but elevated oil prices have begun to fuel (pun intended) inflationary concerns.

Brent Joyce elaborates further:

“The consequences of higher oil prices and limited egress from the region are inflation fears and higher bond yields. For the U.S., elevated borrowing costs complicate the government’s ability to finance an already bloated debt and deficit. Ahead of November midterm elections, voters are frustrated by inflation; the result could be a backlash against the ruling Republican Party.

For Iran, the economic pain inflicted by a full U.S. naval blockade will only increase. Stubborn though the regime may be, it cannot hold out indefinitely without risking total economic collapse.

While the failure of the Middle East ceasefire is a step in the wrong direction, pressure on both sides should encourage a return to negotiations. Oil futures support this view: prices for delivery 12, 24, and 36 months ahead remain in the US$70 range, suggesting markets are not pricing a lasting supply shock.”

While an agreement appears eventual, our main concern is less geopolitical and more macroeconomic. How persistent inflation becomes will be a critical factor in how the Federal Reserve responds.

 

The Fed

There was a lot of anticipation for the FOMC meeting in July. It is important to remember that at this time last year, the US began its easing monetary policy and was slated to continue to decrease rates this year before the conflict in the Middle East. The inflationary concerns, however, may force the Fed to pivot, and many were watching closely for any signs of a potential interest rate increase this year.

Douglas Porter, BMO’s Chief Economist reported:

“Heading into the event, the market had an unusually high degree of uncertainty on the rate decision, in part due to the Chair’s reluctance to offer any guidance whatsoever. The on-hold outcome was largely as expected, and even the 3 dissents in favour of an immediate 25 bp rate hike weren’t a surprise. But what did raise many an eyebrow was Warsh’s tough talk on inflation, accompanied by no real indication that any actions were on offer anytime soon.

The underlying message from the latest slate of U.S. economic reports only muddied the picture, offering no clear direction. Even the Q2 real GDP release was a jumble of mixed messages. The headline 1.5% growth rate was well shy of expectations, but the downside miss was due to weak inventories and another pullback in federal government spending. Meanwhile, consumers (+3.2% a.r.) shrugged off the quarter’s high gasoline prices while AI spending helped drive overall business investment to a hearty 8.4% gain. Suffice it to say that most measures of underlying activity were solid.”

The lack of clarity and transparency from Warsh is a bit concerning, but it looks like he is satisfied with treading water for now. We are continuing to watch for signals that may support a tightening cycle and a rate increase, specifically increased/elevated productivity, or stickier-than-expected inflation.

 

Bottom Line:

We remain in the Green Zone long term but have de-risked our portfolio in the short term by raising cash and taking defensive positions. Due to the seasonal weakness, we expect the markets to trade sideways into September and will also have to be mindful of the US midterm elections in November.

However, the markets have been resilient all year, and we do not see any signs of structural weakness at the moment. As such, we expect to be fully invested once we get a clearer indication of where the markets will head after the summer doldrums.

Brent Joyce summarized:

“Although the last few months have been choppy, fundamentals have improved: inflation cooled more than expected in many countries while employment and growth held up (especially in Canada). Corporate earnings continue to deliver. Shocks can come and go – July saw them come, but they can also fade quickly. Meanwhile, resilient capital markets and economies soldier on.”

As always, should you have any questions regarding your portfolios or planning, or if you would like to meet in person or by phone or video conference, we are pleased and ready to do so.

Regards,

John, Victor and Megan

 

1 https://countryeconomy.com/stock-exchange/usa?dr=2026-07