The second-half setup for stocks: Don't fight the tape but keep expectations in check

Published Sat, Jun 26 20218:41 AM EDT

Through nearly half the year, 2021 has delivered investors about three times more reward than risk, the S & P 500's 14% return coming with a few brief declines of no more than 5%. In markets as in sports, momentum and mean-reversion are always either in force or in reserve, and a win streak reliably spurs a debate over whether a team has built unbeatable chemistry or is "due" for a rough patch. When it comes to stocks, the prevailing trend usually gets the benefit of the doubt. And last week the steady uptrend was defended, as investors collectively concluded the little shakeout from a subtle shift in Fed messaging and a purge of crowded "reflation" trades was unwarranted given all that had not changed about the benign backdrop, as hinted here a week ago . History offers some comfort to the bulls about strength often begetting strength. In the 17 prior years since 1950 when the S & P 500's total return in the first half exceeded 12%, the index continued higher in all but four in the second half, according to Schaeffer's Investment Research. The average second-half return for all those years was 7%. Only once in the four losing years – the notorious boom-and-crash episode of 1987 – did the market give up a significant slug of the first-half gains. So the broad tendencies point higher, though one of the current quibbles with the market's latest push higher is that it hasn't been impressively broad. In fact, last week the S & P 500 made a new record high while fewer than half the index's stocks were even above their individual 50-day moving average, a rare condition of internal disagreement. According to the research service SentimenTrader, this has only happened six times before since 1928, most either in the later, more volatile phases of bull markets or, a couple of times, at significant peaks. That's too small a sample to infer future direction with confidence. And it's a bit of a quirk of the market itself having flattened out quite a bit since mid-April, from which point the S & P is up just over 2%. But if nothing else suggests a more selective tape than has been the case since last fall. Resilient market Speaking of small samples and the market flattening out: The current snapshot of the current 90% rally from the March 2020 low compared to the only two comparable bull-market launch phases is showing a pretty wide divergence in recent months. This chart led to many calls for a downward choppy phase starting in the spring, but, so far, the market has been resilient. It's not too hard to imagine why the ramp since the Covid crash has outdone those earlier celebrated rallies, but some 30 percentage points: The uniquely compressed nature of the economic crunch last year, the almost immediate and overwhelming policy response, the lack of scarring on corporate balance sheets, the return to record earnings within a year and a Fed not looking for reasons not to tighten policy for as long as possible. After a 14% year-to-date gain the S & P 500 is less expensive than six months ago because earnings results and forecasts have risen much faster. Share buybacks are about to come roaring back toward historic highs in this age of corporate prosperity with few hard capital-allocation choices required. Credit conditions are lavishly forgiving – healthcare company Centene carrying a junk-level credit rating from Moody's sold seven-year debt last week at a yield under 2.5%. The S & P 500 Volatility Index (VIX) continues to roll downhill, sitting near 15 and on the cusp of the low-teens where it has settled during the calm, grinding rally phases of recent years. This is not a foolproof or permanent formula for gain without pain, but it is a plausible reason this rally has avoided nasty payback to date. There's also the more typical seasonal weak patch for stocks that tends to begin around mid-July. Though such factors are the softest of inclinations and no match for a strongly trending market in most cases. After all last week – the one following June's options and futures expirations – was supposed to be among the weakest of the year based on decades of history, yet the S & P gained nearly 3%. Threats to derail the bull For sure, the bull market is entering a zone where further good news brings potential offsetting negatives into view and attention will increasingly turn toward prospects for 2022, where tougher comparisons on earnings and less fiscal help await. Citi strategist Tobias Levkovich on Friday laid out a somewhat cautious tactical outlook for the coming months, saying "investors might encounter four different catalysts (tapering discussion, inflation, margin pressures and taxation) that could coalesce around the same time. Sentiment remains ebullient, valuation is not attractive and the Street already expects strong profit trends." He'd rather wait for pullbacks to buy to capture some upside to his modest mid-2022 target for the S & P of 4350 (up less than 2% from Friday's close). Sentiment does appear ebullient from some angles. Overall retail and institutional equity allocations are near historic highs, for instance. And both professional and individual surveys show low numbers of admitted bears on stocks. Yet Deutsche Bank strategists point out systematic and quantitative funds still have middling commitments to stocks relative to history, which might be lifted if the VIX continues lower and drives their models deeper into equities. And the weekly NAAIM survey of active-trading investment advisors showed exposures pulling back toward neutral. Levkovich's own survey of 70 institutional clients on average see no upside to the S & P the rest of the year and 63% of them see a 20% market pullback as more likely than a 20% further rally from here. That doesn't sound ebullient. But neither does it seem irrational in a market that's up huge over 15 months, gone flattish with a loss of momentum the past ten weeks, and where "Don't fight the tape and stay involved, but keep expectations in check" might not be the worst way to play into the second half.

Traders on the floor of the New York Stock Exchange, June 25, 2021.

Source: NYSE

Through nearly half the year, 2021 has delivered investors about three times more reward than risk, the S&P 500's 14% return coming with a few brief declines of no more than 5%.

In markets as in sports, momentum and mean-reversion are always either in force or in reserve, and a win streak reliably spurs a debate over whether a team has built unbeatable chemistry or is "due" for a rough patch.

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