Biggest threat to major pullback in stocks is hard landing for economy
What is the catalyst for a severe pullback? That seemed to be the question everyone was debating throughout the long weekend. It’s not what keeps the stock market going up, it’s what makes it actually go back down. And when I say a pullback, I don’t mean a 5% pullback over the summer. You know that’s coming – it always comes. I’m talking about going back to zero this year. The S&P 500 is up 15% this year. What kind of factors do we need to see to get it back to zero this year? This is where a lot of people get stuck. Everyone knows valuations are high, but earnings trends have picked up lately with the soft landing on the horizon. Technology revenue is growing even faster than overall revenue. To believe in a pullback to zero this year, you have to believe the soft landing won’t last. You have to believe that employment is going to drop sharply, incomes are going to drop suddenly, and interest rates are going to spike beyond the 50 basis points the Fed thinks a rate hike is likely to be. Most people have a hard time making these arguments. History shows just the opposite: In years when the S&P 500 has a particularly strong first half, it also tends to close strongly. Case in point: Since 1980, the S&P 500 has had 10 first-half gains of 15% or more. Ten out of 10 of those occasions ended the year higher, with an average gain of 23% for the year, according to BTIG. The rally is broadening, but it’s slow You’ve heard the common complaint: The technology and communication services sectors account for nearly 90% of the S&P 500’s year-to-date returns, with just seven companies accounting for more than 80% of those gains. Is it advisable to expand the market? Of course it is. Market gains expanded, but not by much. The S&P SmallCap 600 and MidCap 400 both posted advance/decline gains in June, but not nearly as much as the largecap S&P 500 or Nasdaq 100. The S&P P 500 is where most of the money is anyway, the simple fact is that the vast majority of the investing public is invested in S&P 500 stocks, especially the S&P 100. The S&P 500 is 80% of the value of the US stock market. Here’s the good news: the S&P Advance/Decline line has breached the recent February high and is at its highest level since last August. A slightly different measure of the market’s gains: 61% of the S&P 500 is above its 200-day moving average — the highest level since early February. In early June, it was a paltry 37%. If you really want to get excited, let’s see if we can break above February’s level: when 75% of stocks in the S&P 500 were above their 200-day moving average. It hasn’t been this high since September 2021. Given that the biggest gains are in the biggest stocks, what we can reasonably expect at this point is likely to be moderate gains in the rest of the market. “Nevertheless, when we think about the textbook characteristics of bear market cycles, market bottoms and subsequent cyclical upswings, we don’t see a straight-line extension of the upside either,” Ari Wald, senior analyst at Oppenheimer, said in a note to clients over the weekend. It’s hard to find a better example than what’s been going on over the past 18 months.” Stocks face competition from bonds and cash Perhaps the biggest problem for the stock market is that cash and bonds remain a source of shock for stock investors and many others who are pulling from savings Funding and buying short-term stocks offered attractive returns to the Treasury earlier this year. Over the weekend, the Financial Times noted that cash, bonds and stocks were yielding about the same, just over 5%. Sustained high yields on bonds and cash represent competition for stocks. The Financial Times article quoted Christian Kopf, head of fixed income at Union Investment, as saying: “Now we have inflation problems that lead to big rate hikes, which means the stock market is much less attractive.”
