SUMMER STOCK SLOWDOWN BUZZ IS ... HEATING UP
After reaching record highs more than a year after its previous peak, market might be setting up for a pause
With the Standard & Poor’s 500 stock index hitting a record in July and a tad pricey relative to history, some Wall Street pros are sounding the alarm about a potential summer pullback.
Angst is visible in recent Wall Street reports that deliver messages of short-term caution: “Testing time for the bull?” writes Gina Martin Adams, equity strategist at Wells Fargo Securities. “S&P summer sizzle: Don’t get burned,” warns David Bianco, strategist at Deutsche Bank. “Some reasons to expect August to be a down month,” adds Tom Lee of Fundstrat Global Advisors.
Yellow flags are as plentiful on Wall Street as yellow beach umbrellas along the U.S. coastline. The S&P 500’s inability to make a fresh high this week could be signaling broader investor hesitancy. The benchmark index was at 2,170 Thursday, or 0.2% shy of its all-time high hit last Friday, ending its best week since May 2015.
None of the strategists are calling for a steep decline or the end of the seven-year bull market. But they say a pause is possible. Most are advising clients to buy on any dip, as they expect stocks to move higher after any drop. Lee sees the S&P 500 gaining 8% to 10% in the second half of 2016, but says he’s “scared about August.”
While new highs after a wait of a year or more tend to be bullish, historical performance data show the S&P 500 “tends to see a pause over the next month” after hitting a new peak, Lee says. After 13 new peaks after year-long droughts since 1954, the S&P 500 was up an average of 1% a month later vs. gains of 4% three months later and 12% returns a year later.
Also worrying Lee is that normally placid bonds currently are more volatile than stocks. That uncommon relationship — which Lee says signals investor “complacency” — has proved to be a “short-term negative” for stocks, with the S&P 500 declining 1.3%, on average, and down 68% of the time, a month later after similar periods.
Another yellow flag is August’s recent reputation as a bad month for stocks, with the S&P 500 finishing lower four of the past six years, with declines often steep.
Recent rumblings of a coming interest rate increase could dent investor sentiment. There’s a risk Wall Street will be caught off guard by an earlier-than-expected increase from the Federal Reserve. In a statement Wednesday, the Fed said, “Nearterm risks to the economic outlook have diminished.” That opened the door to a hike as early as September, analysts warn.
“The rally now is being supported by one prop — no Fed tightening,” says Nick Sargen, senior investment adviser at Fort Washington Investment Advisors. “If the Fed moves later this year, I would expect a noticeable correction (or stock decline).”
Another potential factor: Corporate earnings season. “The real earnings test is yet to come for stocks,” she says.
Bianco warns stocks could suffer a dip of 5% to 9% in the run-up to the presidential election because of risks related to corporate earnings and rising valuations.
The S&P 500 is trading at 18.3 times its trailing 12-month earnings, the highest level since November 2004, according to Burt White, chief investment officer at LPL Financial. “Stock market corrections tend to be more painful when they come at higher valuations,” White noted in a report, adding most bull markets since World War II have ended at P-E levels similar to today’s.