How is the stock market set up heading into summer?
It's hard to make a confident case the summer of 2018 will either be "hot fun" or particularly cruel.
The weight of the evidence tilts toward some more aimless knocking around, punctuated by a few bursts of excitement, and probably a couple of attempts by the bears to raid investors' picnic.
Memorial Day weekend marked four months since the major indexes peaked in a crescendo of heedless optimism and maximum momentum, and the past two have seen them settle into a tight band.
Call it rediscovered stability or stalemate or indecision, but whatever the characterization, the has been well-anchored near the middle of its 2018 range. At Friday's close of 2721, the index was up 5.4 percent from its Feb. 8 closing low, and it would take a 5.5 percent gain from here to match the Jan. 26 all-time high.
The tape showed impressive resilience in April, refusing to buckle despite several trips toward the lower end of the 2018 range. But the thrust behind rallies has been unimpressive and the strength has been selective and shifting within the market.
The forces holding the market in this zone are well-known to the point of being taken for granted now: supported by fast-rising corporate profits, solid consumer trends and favorable credit conditions, while hampered by somewhat higher bond yields, suspense about rising inflation and persistent questions about how much profitable life is left in this cycle.
It's tough to see how any of these factors resolve themselves decisively in one direction or the other in the next couple of months. The long-term trend still favors the bulls and will continue to so long as the S&P holds within a few percent of the current level. Yet on a tactical basis in the short term, the aggressive equity optimists have a bit more to prove. Recent rallies have failed to surmount the threshold on the S&P 500 — around the 2750 mark — from which stocks fell hard two months ago on a swirl of China trade salvos, Facebook privacy scandal and the latest Federal Reserve rate hike.
The valuation of stocks relative to bond yields — to cite one big-picture relationship — has been steady at levels that seem neutral based on the past decade or so.
The 10-year Treasury hit 2.94 percent in a rush higher on Feb. 21; the yield finished Friday at 2.93 percent on a pullback. On both dates, the S&P sat a bit above 2700. There's nothing necessarily rigid about that relationship over time, but these asset classes seem engaged in a sort of uneasy equilibrium for the moment.
Back to lows?
Global strategist Michael Hartnett at Bank of America Merrill Lynch has set out what would likely need to happen for the market to break one way or the other out of its sticky range.
For a drop to fresh lows, a slide in U.S. GDP and earnings forecasts and some sort of credit "contagion." (It would be a decidedly odd, though not unprecedented, year if earnings were up 15 percent or more, as now anticipated, and stocks stayed flat or fell.)
To regain the January highs, he thinks the Fed and President Trump must "blink" and cut back on rate hikes and trade aggression, respectively, while stock buybacks and perhaps a reanimated tech-stock lovefest emerges. It's quite unclear much of this would have time to develop, say, by July 4, though of course markets attempt to front-run the next economic plot point.
Researchers who study the aggregate bets of the big-money index-options traders for clues about which way the index might be pulled say the pricing of bets expiring in late August suggest a flattish summer that chops around but shouldn't be too far from 2700. (These traders' positions collectively don't always bunch together near the current index price, for those wondering.) The good news is, options dealers don't see deep and lasting damage to come in summer, but they also aren't betting on a summer surge.
The familiar seasonal patterns have not been all that helpful to traders and investors in recent years, proving that they are merely broad tendencies and not cues for action. Still, for what they're worth, this year they seem a headwind.
The hackneyed "sell in May" idea that May-October returns have been weak over the decades has failed in recent years as stocks made good headway in that half a year. But it's in years when the market was down year to date through April — as it was this year — when the historical weakness mostly shows up. In such years, the May-October S&P 500 return has averaged a 2.9 percent loss.
And Stock Trader's Almanac chimes in that June in midterm election years since 1950 ranks dead last for average returns.
2014 a guide?
I've been keeping an eye on the comparison of this year's market path with that of 2014. Why? Both years were preceded by unusually strong years (2013 and 2017) with extraordinarily low volatility. Early in each 2014 and this year, there was a nasty shakeout lower amid complacent investor sentiment. In each year, too, the Fed was entering a new phase of removing "easy money" policy — ending QE in 2014 and reducing its balance sheet this year while lifting short-term rates.
As the charts show, the paths are not dissimilar, though the January run-up and February drop this year were more dramatic.
As of Memorial Day weekend in 2014, the S&P was up 2.8 percent, and now is up 1.8 percent. In 2014, credit markets stayed firm and the economy and earnings held up well, but as the highlighted box shows, the market made very little net headway through October before a strong finish to the year.
Source: Yahoo Finance
Source: Yahoo Finance
Not a prediction, just something to ponder over the long days of summer.