Since mid-June, the S&P 500 has racked up 17% gains after entering bear market territory. Several companies that make up the index have had a good earning season, allowing investors to invest in cheap stocks. The combination of good quarterly results as well as a closing of short covering created an environment beneficial to this rally. However, the index, which had peaked on August 18, was down 7.8% as of September 2. According to many analysts, this was expected at that time when the S&P 500 was “overbought” and a pullback was necessary to correct this situation.
The NASDAQ also had a good summer. Rising stocks from the tech sector helped it post gains of more than 23% from mid-June through mid-August.
The NASDAQ was propelled by the rise in technology stocks which had registered decline after decline since the beginning of the year. For example, Apple’s stock is up 27% while Amazon gained 36% during the summer period.
Apple, with its market capitalization of $2.75 trillion, makes up 7.4% of the S&P 500, the highest weighting of any stock in decades. This makes the stock more valuable than the energy and materials sectors combined, and nearly as large as the industrial sector 7.9% weighting in the NASDAQ index.
This summer rally faded towards the middle of August when many felt that the easy money had been won. Indeed, the NASDAQ, as of the beginning of September, is down 24% since January, despite the gains accumulated this summer. The surge observed in the technology sector, as many have bought stocks at a “discount,” could be short-lived.
“Earnings reports so far for the second quarter have led to significant downward adjustments to profit forecasts for the NASDAQ 100 including a 5.5 per cent cut to the 2022 estimate and a 6.5 per cent cut to the 2023 forecast. This will translate into billions being wiped off the earnings of U.S. tech companies,” Lapthorne said.
Canaccord Genuity’s Martin Roberge expects earnings forecasts to slip through the fall. “Revenues (which have benefited greatly from the swelling effect that inflation has on business income) will become less vigorous. Let’s not forget that the economic slowdown really started in July.”
In short, the summer rally has faded following the comments of the Fed on August 26. The central bank has announced that it wants to put an end to inflation and is planning other interest hikes resulting in the fall of the three main US indexes.
“Restoring price stability will likely require tight policy to continue for some time,” Powell said in a speech at the Fed’s annual meeting in Jackson Hole, Wyoming. “While higher interest rates should create slower growth and labour market conditions should ease, but will certainly cause pain for households and businesses.”
Raising interest rates remains an effective strategy to slowdown the economy when inflation is at its peak, when it becomes more difficult for companies and individuals to borrow money (easy money). Investors understood that there would be no easing of monetary policy from the Fed in the short term.
“He was more explicit than ever before in clearly stating that interest rates will continue to remain high for a longer period in order to fight inflation,” commented the vice-president of AGF Investments, Mike Archibald. “It has put pressure on various branches of the capital markets, and certainly on equities today,” he added.
The Fed has become the main driver of the markets. For example, when it becomes more hawkish, the market can go down for several consecutive days (at the June low, the S&P was down 5 days out of 6, a loss of about 12%). Buying just because the market is oversold does not necessarily work in this context.
As long as inflation persists, and there is no other alternative method to fight inflation other than rising interest rates, markets will remain highly volatile, both down and up. Nervousness is relatively high and the market reacts strongly to all types of geopolitical and economic news. Right now, good economic news tends to have the opposite effect and cause markets to react lower, as investors believe it gives the Federal Reserve more flexibility for future interest rate hikes.
Summer is over
What can we expect for the month of September? Seasonal trends demonstrate that this month is often tougher especially when indexes have been falling since early August, Bespoke Investment Group analysts said, citing S&P 500 performances dating back to 1928.
Despite the rebound in July and early August, the S&P 500 has retreated over the past two weeks. The month of August had started well, but the latest speech from the Fed created a climate of uncertainty in the markets. Thus, the S&P 500 recorded a decline of 4.2% for the month, the Dow of 4.1% and the NASDAQ accumulated losses of 4.6% in August.
The back-to-school period should be interesting on several levels as the economy continues to slowdown, still under the effect of monetary and fiscal tightening by central banks.
According to the Stock Trader’s Almanac, September is typically a down month for the stock market, as fund managers tend to sell underperforming positions as the end of the third quarter approaches.
The good news? Many believe that the worst of this bear market is behind us. The rebound in mid-August indicates that the S&P 500 had recovered more than half of its 24% drop from the January bull market high to its June low. According to research firm CFRA, in the 13 bear markets that followed World War II, the S&P 500 never hit a new low after a rebound of this magnitude, a situation known as a 50% retracement.
If history is anything to go by, a rather important technical indicator was hit earlier in August, when the S&P 500 recovered 50% of its price decline in the bear market. Since World War II, the index has not hit a new low after such a move, according to Sam Stovall, chief investment strategist at CFRA Research. Additionally, the number of S&P 500 stocks above their 50-day moving average recently hit 90%.
For now, it is difficult to assess whether we are finally out of the bear market as opinions differ on how to spot an expiring bear market or the start of a new bull market. For many analysts, a bull market is defined as a 20% rise from a previous low. While for others, we can only be sure of a new bull market once an all-time high has been reached.
The seasonal trend for September is not favourable. However, the fourth quarter beginning in October tends to be the best quarter of the year. Stronger-than-expected earnings and a few surprises could easily force several investors to cover their short position and thus, force the start of a new bull market.
In conclusion, we remain dependent on the Fed’s next decisions, which will be linked to the next economic data (CPI, inflation). We believe that a recession is probably still avoidable and that a “soft landing” is still possible.
Pratte Portfolio Management is a firm registered with the Autorité des marchés financiers (AMF) and the Ontario Securities Commission (OSC).
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