July looked like a relatively quiet month if you only watched the S&P 500 or the Dow. Both indexes spent most of the month trading sideways, and the headline numbers did not make it look like much had happened.
Under the surface, however, there was a lot of movement.
Semiconductors, South Korean stocks, the Nasdaq, and many of the areas connected to the artificial intelligence trade experienced significant drawdowns. At the same time, money rotated into financials, healthcare, energy, software, banks, and some of the more defensive parts of the market.
The other major development was in the bond market. The Federal Reserve held short-term rates steady, but longer-term Treasury yields continued moving higher.
I think that may be one of the most important things for investors to watch going into August.
Momentum Stocks Struggled in July 2026
As I mentioned in my June market review, July has historically been a challenging month for momentum strategies.
One possible explanation is fairly straightforward. The beginning of July marks the start of the second half of the year, which is a natural time for portfolio managers to rebalance.
If a manager has a target allocation, rebalancing generally means trimming some of the investments that have performed the best and adding to areas that have lagged.
During the first half of 2026, many of the biggest winners were connected to artificial intelligence. That included semiconductors, South Korean and Taiwanese technology companies, data-center-related industrial companies, and other stocks included in momentum indexes.
When investors began reducing exposure to those winners, many of those trades started unwinding at the same time.
That helps explain why the broad S&P 500 appeared relatively calm while there was considerably more damage in the Nasdaq, semiconductors, emerging markets, and South Korean stocks.
In many cases, those were not really separate trades. They were different versions of the same AI and momentum trade.
What Happened Beneath the S&P 500?
The S&P 500 spent much of June and July trading in a relatively narrow range. It appeared to break out at one point and then quickly reversed. It later looked like it might break down, only to reverse again.
Those false starts made the headline index look uneventful.
Elsewhere, however, there was a fairly broad rotation.
Energy benefited from higher oil prices. Financials, bank stocks, healthcare, software, and some defensive areas also performed better as money moved away from semiconductors and other former market leaders.
That type of rotation is not necessarily unhealthy.
The more concerning situation would be money leaving nearly every part of the stock market at the same time. That is not what we saw throughout most of July.
The S&P 500 advance-decline line reached a new high near the end of the month, and credit spreads remained relatively well behaved. Those are two reasons I am not ready to conclude that the broader market is breaking down.
There was real damage in the momentum trade, but there were also signs that money was rotating rather than simply leaving the market.
Leverage Works Both Ways
One of the biggest lessons from July was the danger of leverage.
Leverage allows an investor to control more exposure than the amount of capital actually invested. When a trade is moving in the right direction, it can produce very large gains.
The problem is that it has the same effect in reverse.
South Korean stocks, for example, rose approximately 92% from their March lows before declining roughly 35% from their peak. A product providing three times the daily exposure produced a much larger gain on the way up, but then experienced a drawdown of more than 80%.
The same thing happened in semiconductors.
The underlying semiconductor index more than doubled from its March low before falling close to 30%. A three-times-leveraged semiconductor product gained more than 250% during the rally and then lost close to 70% during the decline.
That is the part of leverage that is sometimes overlooked.
A 30% decline is painful, but it is survivable. A 70% or 80% loss can effectively wipe out an investor or force a leveraged fund to liquidate its positions.
Leverage can be useful in certain situations and for very specific trades. I used leverage myself when I traded futures. But it needs to be treated with respect.
The longer leverage is used and the more concentrated the underlying trade becomes, the greater the possibility that a normal market correction turns into something much worse.
Federal Reserve Holds Rates Steady in July 2026
The Federal Reserve held its policy rate steady at its July meeting.
The reaction in the bond market was interesting.
Shorter-term Treasury yields initially came down somewhat, but the long end of the yield curve moved higher. The 30-year Treasury yield reached its highest level in nearly two decades.
That is not the reaction investors would generally want to see following a Federal Reserve meeting.
One of my favorite charts compares the two-year Treasury yield with the federal funds rate. Historically, the Federal Reserve tends to follow the two-year yield rather than lead it.
At the end of July, the two-year Treasury yield was trading noticeably above the Fed’s policy rate. Based on that spread, the bond market appears to believe that monetary policy is relatively loose.
My interpretation is that the market may be telling the Federal Reserve that it made a policy error by not raising rates.
That does not guarantee that the Fed will hike at its next meeting. The data can change, oil prices can fall, geopolitical tensions can ease, and inflation can improve.
For now, though, the bond market appears uncomfortable with the combination of rising commodity prices, large federal deficits, and a Federal Reserve that is holding short-term rates steady.
Why Higher Long-Term Interest Rates Matter for Investors
Most investors have heard of the traditional 60/40 portfolio: 60% stocks and 40% bonds.
That approach worked especially well during the long decline in interest rates that lasted from the early 1980s through 2020.
When stocks struggled, Treasury yields often fell and bond prices rose. Bonds provided income and helped offset some of the volatility on the stock side of the portfolio.
The environment began changing in 2022.
Inflation forced the Federal Reserve to raise rates aggressively, and stocks and bonds declined at the same time. Since then, the long-term trend in interest rates has looked very different from the one investors became accustomed to during the previous four decades.
That does not mean the 60/40 portfolio is permanently broken.
It does mean that investors may need to be more thoughtful about what they own within the 40% allocated to fixed income.
How I Have Adjusted Fixed-Income Portfolios
I may still have a strategic allocation to fixed income in client portfolios, but I have changed the types of fixed-income investments I use.
When rates are trending higher, it generally does not pay to maintain large exposure to long-duration bonds. Bond prices and interest rates move in opposite directions, so longer-term bonds tend to experience larger declines when yields rise.
That has led me to focus more heavily on areas such as:
• Treasury bills
• Floating-rate Treasury securities
• Short-term credit
• Bonds with relatively low interest-rate sensitivity
This is not a permanent decision.
At some point, long-term yields may become attractive enough to bring in pension funds and other large institutional investors. Inflation could also fall, geopolitical concerns could ease, or economic growth could slow.
For now, though, the trend remains important. When the yield chart is moving from the bottom left to the top right, investors need to be careful about taking unnecessary duration risk.
Oil and Inflation Expectations Are Moving Together
Oil and gasoline prices also deserve attention.
Gasoline futures moved significantly higher during the first seven months of the year. Over that same period, Treasury yields and market-based inflation expectations also moved higher.
That relationship makes sense.
When investors expect stronger growth or higher inflation, they generally demand more compensation for holding long-term bonds. They sell bonds, prices fall, and yields rise.
Higher oil and gasoline prices can also work their way through the economy. They affect transportation costs, household budgets, and the cost of producing and delivering other goods.
Agricultural commodities can create similar pressure.
If oil, gasoline, diesel, and food-related commodities continue rising, it becomes more difficult for inflation to return to the Federal Reserve’s target. That could keep interest rates higher and may eventually force the Fed to tighten monetary policy again.
What Higher Rates Could Mean for Investors
If long-term yields continue rising, the effects will not be limited to bond portfolios.
Mortgage rates could move higher, putting additional pressure on housing activity and affordability.
Companies and households may face higher debt-service costs.
Stocks may also face more competition from fixed income. If investors can earn an attractive yield on relatively safe bonds, they may be less willing to pay high valuations for stocks.
None of those outcomes is guaranteed, and the situation could change quickly.
But the speed of the move matters. A gradual increase in yields is different from a disorderly spike. The faster rates rise, the greater the possibility that they begin creating problems elsewhere in the financial system.
Market Outlook: What I’m Watching in August 2026
Going into August, I am watching three things.
The first is whether the rotation out of semiconductors and the momentum trade continues or whether those former leaders begin to stabilize.
The second is whether the broader market remains healthy. The recent strength in market breadth and credit spreads is encouraging, but that will need to continue.
The third, and probably the most important, is the direction of interest rates.
Oil prices, gasoline prices, agricultural commodities, federal deficits, and inflation expectations can all influence the bond market.
If yields stabilize or begin moving lower, that would remove some pressure from stocks, bonds, mortgages, and the housing market.
If they continue moving sharply higher, investors may need to adjust.
The S&P 500 may have looked relatively calm in July, but the movement underneath the surface told a much more complicated story. As we move into August, the bond market may provide the clearest indication of what comes next.
JTM Williams Capital Management provides financial planning and investment management from offices in Alexandria, Virginia, and Bridgeport, West Virginia, serving clients nationwide. If you have questions about how changing interest rates, inflation or market conditions could affect your financial plan, schedule a complimentary consultation.
Matt Williams, CFP®
JTM Williams Capital Management
The investments, indexes, ETFs, and strategies discussed are for informational and educational purposes only and do not constitute a recommendation to buy or sell any security. Investing involves risk, including the possible loss of principal.
