Welcome to Five in Five, a monthly publication from the Investment Team at BTC Capital Management. Each month we share graphs around five topics that illustrate the current state of the markets, with brief commentary that can be absorbed in five minutes or less. We hope you find this high-level commentary to be beneficial and complementary to Weekly Insight and Investment Insight.

This month’s Five in Five covers the following topics:

1. ISM Indices Diverge
2. Interest Rates React to PMI Manufacturing & Employment Data
3. Markets Reflect Increased Credit Risk
4. July Small Cap Versus Large Cap
5. S&P Earnings Yield Decline Signals Excess Equity Risk Premium

1. ISM Indices Diverge

• The Institute for Supply Management Purchasing Managers’ Index (ISM PMI) Survey Indices of manufacturing and services landed on different sides of the growth/contraction line of demarcation in July.
• The manufacturing survey index registered a reading of 46.8, its lowest level since April 2020. This was the fourth consecutive monthly contraction.
• The services survey index saw its results pop back up above the dividing line of 50.0 with a result of 51.4. The previous month’s reading was 48.8.
• The new orders component of the manufacturing index continued to weaken, and the orders backlog also continues to be in contraction territory.
• The services survey index, with its reading of 51.4 was back in growth territory as the new orders and prices components moved higher indicating a stronger level of economic resilience than its manufacturing counterpart.

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2. Interest Rates React to PMI Manufacturing & Employment Data

• As noted last month, the bond market is now fully focused on growth.
• The Fed opened the door for a rate cut in September but noted there is currently no discussion of a 50-basis point (bps) cut.
• Weak PMI and employment readings sparked a three-day rally of 45 bps in the two-year yield.
• Recession scare is now in full swing with the Fed failing to cut and a long wait until the September meeting.
• The market is starting to price in back-to-back 50 bps cuts in September and November.

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3. Markets Reflect Increased Credit Risk

• Corporate bond spreads have been near record tight levels for most of the year.
• They offered a poor risk/reward set-up despite a decent overall yield.
• Mortgage-backed securities (MBS) tend to perform better than corporate bonds during risk-off windows.
• Should a recession occur, high-yield spreads historically hit at least 800 bps.
• Even without a recession, the low for spreads is likely in this cycle.

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4. July Small Cap Versus Large Cap

• During the month of July, small cap stocks (Russell 2000) significantly outperformed large caps (Russell 1000).
• Investors rotated out of large cap stocks as concerns regarding lofty valuations arose.
• Year-to-date, large caps have outperformed small caps (15.9% versus 12.1%) as they did last year, as well (26.5% versus 16.9%). It remains to be seen if small caps will continue their relative outperformance given strong forecasted earnings growth from large caps.

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5. S&P Earnings Yield Decline Signals Excess Equity Risk Premium

• The S&P 500 earnings yield (the inverse of P/E) has moved closer inline with the yield on the 10-year Treasury.
• Investors use this metric as a measure to gauge if the excess equity risk premium is sufficient versus the 10-year.
• As the market’s P/E rises to lofty valuations, the earnings yield declines, closing the gap with the current yield on the 10-year.

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Sources: BTC Capital Management, Institute for Supply Management, Bloomberg, FactSet, LSEG Refinitiv
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.

This document is intended for informational purposes only and is not an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of  principal. Investments are not FDIC insured and may lose value.