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The major market indexes have regained much of the ground lost last year, with many individual stocks even eclipsing their highs from 2021. Yet this year’s incredible stock market rally has been halted to kick off the historically subpar month of August. U.S. government and domestic bank ratings downgrades, along with a reversal in seasonal tendencies, have brought on increased selling pressure as market participants understandably take profits.
The months of August and September are typically associated with negative seasonality, as this two-month stretch has historically witnessed the worst performance relative to any other similar period of the calendar year. Dating back to 1950, when the S&P 500 has risen more than 17.5% heading into August, the month has been lower 8 out of 11 times and down an average of -1.1%.
And after such a remarkable rally through the first seven months, it’s easy to understand why most Wall Street strategists are expecting weakness in the short-term. The S&P 500 soared nearly 20% through July, its best start to the year since 1997. Following such a rare occurrence, it’s natural to question whether or not the momentum can continue.
Distribution Days Build Up
We’ve seen some distribution over the past few weeks, beginning with a big outside day in the S&P 500 (SPY - Free Report) on July 27th. This was followed by more downside distribution days last week along with another bearish engulfing candle, and suggests that the pullback has not yet run its course.
Image Source: StockCharts
Another concerning part of the recent action was a rise in the VIX Index, which generates a 30-day forward projection of volatility and is derived from the prices of S&P 500 index options. The VIX index soared more than 40% from late July through yesterday, August 8th. It’s clear that the market has come under pressure in recent weeks.
There’s no doubt that certain pockets of the market are due for a breather, particularly the more extended areas such as technology and home builders. Still, the rally this year has been based on strong fundamentals including increasing earnings estimates, which our research has shown to be the most powerful force impacting stock prices. Over the long run, stock performance tends to follow the path of corporate earnings.
Let’s review several reasons why this pullback may be more muted and short-lived than many investors are currently anticipating.
Continued Deceleration in Inflation
Inflation measures have shown repeated signs of slowing. The Consumer Price Index (CPI), which measures the change in prices paid by consumers for goods and services, has been showing steady deceleration from a peak of more than 9% last summer. The most recent data showed that the CPI rose 3% year-over-year in June, the smallest 12-month increase since March 2021. Tomorrow morning we’ll receive CPI data from July.
Image Source: YCharts
Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, has confirmed the slowing trend. Core PCE excludes the more volatile food and energy components, and as we can see below, has been gradually trending downward as well. The June data showed that prices rose 4.1% year-over-year, the slowest pace in nearly two years.
Image Source: YCharts
The Fed’s plan of swiftly raising interest rates appears to have worked for the time being. Philadelphia Fed President Patrick Harker indicated yesterday that the Fed may be at the end of its current rate-hike cycle, stating “I believe we may be at the point where we can be patient and hold rates steady, letting the monetary policy actions we have taken do their work.” Markets are pricing in a roughly 87% chance of a pause at the September meeting.
1995 – A Blast from the Past?
I’m not big on analog years, but this year is displaying some striking similarities to that of 1995. With a correlation coefficient of nearly 0.8 through July, we can see why the two years have a lot in common.
Image Source: StockCharts
The S&P 500 returned 18.6% through the first half of that year, roughly in line with 2023. The Fed Funds Rate was also headed higher through the first half of ’95, just as it has been this year. The second half of that year returned 13.1%, ending in a total annual return of 34.1%.
Another similarity that this year shares with 1995 is the fact that a bullish technological theme was developing. While the invention of the internet was made in the prior decades, the phenomenon really caught on in the mid ‘90s. The number of websites grew from 130 in 1993 to over 100,000 at the start of 1996. This year, the onset of artificial intelligence has been all the hype, bolstering the stock prices of technology stocks.
Positive Historical Statistics
2023 is a pre-election year, which is the strongest year out of the 4-year Presidential Cycle. Another bullish data point is the notion that dating back to World War II, there has never been a recession in a pre-election year.
Given that we had a nasty bear market last year, it was difficult to see the light at the end of the tunnel. But those that knew their market history were incorporating a high probability that things would soon turn around. Dating back to 1962, a greater than 25% bear market was followed by an average gain of 38% in the following year.
Image Source: Zacks Investment Research
Furthermore, strong gains in the first half tend to be followed by further, albeit smaller, gains in the second half. Since 1950, when the S&P 500 has risen 10% or more in the first half, the second half has been positive nearly 82% of the time with an average gain of 7.7%. The historical statistics point to the idea that this will be a ‘buyable’ market pullback.
Image Source: Zacks Investment Research
What to Do Now
With the market showing signs of distribution, now isn’t the time to get overly aggressive. Even if we expect a decent second half of the year, it likely won’t come without some form of volatility.
Sector rotation has occurred in recent weeks, as market participants take profits in tech stocks and move to areas that have just broken out such as industrials. This is completely normal price action and is a healthy sign that this bull market can be sustained as market breadth broadens out.
Look for stocks that are holding up well through this pullback and still experiencing some levels of buying pressure, as they will likely be the names that will surge to new highs once the market regains its footing.
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Here's What to Know About This Market Pullback
The major market indexes have regained much of the ground lost last year, with many individual stocks even eclipsing their highs from 2021. Yet this year’s incredible stock market rally has been halted to kick off the historically subpar month of August. U.S. government and domestic bank ratings downgrades, along with a reversal in seasonal tendencies, have brought on increased selling pressure as market participants understandably take profits.
The months of August and September are typically associated with negative seasonality, as this two-month stretch has historically witnessed the worst performance relative to any other similar period of the calendar year. Dating back to 1950, when the S&P 500 has risen more than 17.5% heading into August, the month has been lower 8 out of 11 times and down an average of -1.1%.
And after such a remarkable rally through the first seven months, it’s easy to understand why most Wall Street strategists are expecting weakness in the short-term. The S&P 500 soared nearly 20% through July, its best start to the year since 1997. Following such a rare occurrence, it’s natural to question whether or not the momentum can continue.
Distribution Days Build Up
We’ve seen some distribution over the past few weeks, beginning with a big outside day in the S&P 500 (SPY - Free Report) on July 27th. This was followed by more downside distribution days last week along with another bearish engulfing candle, and suggests that the pullback has not yet run its course.
Image Source: StockCharts
Another concerning part of the recent action was a rise in the VIX Index, which generates a 30-day forward projection of volatility and is derived from the prices of S&P 500 index options. The VIX index soared more than 40% from late July through yesterday, August 8th. It’s clear that the market has come under pressure in recent weeks.
There’s no doubt that certain pockets of the market are due for a breather, particularly the more extended areas such as technology and home builders. Still, the rally this year has been based on strong fundamentals including increasing earnings estimates, which our research has shown to be the most powerful force impacting stock prices. Over the long run, stock performance tends to follow the path of corporate earnings.
Let’s review several reasons why this pullback may be more muted and short-lived than many investors are currently anticipating.
Continued Deceleration in Inflation
Inflation measures have shown repeated signs of slowing. The Consumer Price Index (CPI), which measures the change in prices paid by consumers for goods and services, has been showing steady deceleration from a peak of more than 9% last summer. The most recent data showed that the CPI rose 3% year-over-year in June, the smallest 12-month increase since March 2021. Tomorrow morning we’ll receive CPI data from July.
Image Source: YCharts
Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, has confirmed the slowing trend. Core PCE excludes the more volatile food and energy components, and as we can see below, has been gradually trending downward as well. The June data showed that prices rose 4.1% year-over-year, the slowest pace in nearly two years.
Image Source: YCharts
The Fed’s plan of swiftly raising interest rates appears to have worked for the time being. Philadelphia Fed President Patrick Harker indicated yesterday that the Fed may be at the end of its current rate-hike cycle, stating “I believe we may be at the point where we can be patient and hold rates steady, letting the monetary policy actions we have taken do their work.” Markets are pricing in a roughly 87% chance of a pause at the September meeting.
1995 – A Blast from the Past?
I’m not big on analog years, but this year is displaying some striking similarities to that of 1995. With a correlation coefficient of nearly 0.8 through July, we can see why the two years have a lot in common.
Image Source: StockCharts
The S&P 500 returned 18.6% through the first half of that year, roughly in line with 2023. The Fed Funds Rate was also headed higher through the first half of ’95, just as it has been this year. The second half of that year returned 13.1%, ending in a total annual return of 34.1%.
Another similarity that this year shares with 1995 is the fact that a bullish technological theme was developing. While the invention of the internet was made in the prior decades, the phenomenon really caught on in the mid ‘90s. The number of websites grew from 130 in 1993 to over 100,000 at the start of 1996. This year, the onset of artificial intelligence has been all the hype, bolstering the stock prices of technology stocks.
Positive Historical Statistics
2023 is a pre-election year, which is the strongest year out of the 4-year Presidential Cycle. Another bullish data point is the notion that dating back to World War II, there has never been a recession in a pre-election year.
Given that we had a nasty bear market last year, it was difficult to see the light at the end of the tunnel. But those that knew their market history were incorporating a high probability that things would soon turn around. Dating back to 1962, a greater than 25% bear market was followed by an average gain of 38% in the following year.
Image Source: Zacks Investment Research
Furthermore, strong gains in the first half tend to be followed by further, albeit smaller, gains in the second half. Since 1950, when the S&P 500 has risen 10% or more in the first half, the second half has been positive nearly 82% of the time with an average gain of 7.7%. The historical statistics point to the idea that this will be a ‘buyable’ market pullback.
Image Source: Zacks Investment Research
What to Do Now
With the market showing signs of distribution, now isn’t the time to get overly aggressive. Even if we expect a decent second half of the year, it likely won’t come without some form of volatility.
Sector rotation has occurred in recent weeks, as market participants take profits in tech stocks and move to areas that have just broken out such as industrials. This is completely normal price action and is a healthy sign that this bull market can be sustained as market breadth broadens out.
Look for stocks that are holding up well through this pullback and still experiencing some levels of buying pressure, as they will likely be the names that will surge to new highs once the market regains its footing.