Persistent stock market rally keeps dips shallow, easily shaking off occasional flashes of worry

Published Sat, Jul 10 20217:52 AM EDT

The shadow of doubt has kept the stock market from overheating all year. Last week's show of resilience – a mere 1%, one-day shakeout that was fully reversed Friday and then some – was just the latest illustration of the way a persistent rally is sustained by occasional flashes of worry that it's in jeopardy. What would investors have been so concerned about headed into Thursday's wobble, one might ask? The S & P 500 had just completed a seven-day win streak raking it to a record high and five straight quarters of at least a 5% gain. Yet the unexpected and unwelcome drop in Treasury yields was reinforcing a belief in a decelerating world economy while undercutting popular cyclical sectors. The breadth of the rally was rightly said to be lacking, with statistics about how few stocks were trending higher in heavy circulation. And whippy, indecisive sector and style leadership this year – first speculative-growth, then "reflation plays" in small-caps and cyclicals, giving way to a forceful resurgence of stable mega-cap growth – has made it hard for any group of investors to feel they had things figured out, keeping overconfidence at bay. The poor breadth and constant rotation all year meant that by early Thursday – with bond yields squeezing lower toward a five-month low and countries re-imposing restrictions to combat Covid outbreaks – plenty of stocks were already down quite a bit and the downside flush that morning made them oversold and ripe to bounce. About half of all S & P 500 components were at least 10% off their high even with the S & P down less than 2%, and more than 2,300 individual names made a one-month low, the highest such reading all year and enough usually to invite a strong bounce. At the same time, the air leaking from economically sensitive groups had left transports, homebuilders and banks in 10% corrections, relieving valuation and technical excesses but to little net harm for the broad indexes, which were getting support from breakouts in long-stagnant Amazon and Apple (together comprising more than 10% of the S & P 500). This sort of benign, almost choreographed, ebb and flow might seem unlikely to continue but has lasted all year, placing a safety net just a few percent beneath the market as it's climbed. A long time without a 5% sell-off Ned Davis Research shows here that the S & P is now in its second-longest streak of the past decade without at least a 5% pullback on a closing basis. As the vastly longer streak from mid-2016 into early 2018 shows, nothing says such shallow dips and grinding progress can't go on a while longer. I've noted a few times that the market setup and behavior in 2021 resembles that of the past two post-election years , 2017 and 2013, with their low-drama uptrends and constant rotations among sectors and styles The 2013 experience also featured the famous "taper tantrum" that sent Treasury yields soaring (and then declining) on a hint of the Federal Reserve reducing bond purchases, triggering a fleeting 6% S & P dip before the markets made peace with a gradual wind-down of QE. Sound familiar? In fact, the S & P at this point in 2013 was up almost the same amount it is now (15.9% vs, 16.5%). Yes, plenty was different then: Equities were objectively cheaper, the S & P only that spring hit its first decisive record high in 13 years and investors had lower allocations to equities than they do now. In 2017, excitement over a coming corporate tax cut and the recovery from a 2016 industrial and earnings recession were strong tailwinds – insulating the market from significant pullbacks until reckless bets against volatility spiraled and a crescendo of overconfidence built up before bursting in January 2018. From then, a flash correction initiated more than a year of no net progress for the market even as the economy and earnings did fine. This is why the bulls should prefer the current market to stop short of excessive optimism and pervasive investor certainty over the economic outlook. No formal alarm rings when those hazardous thresholds are reached, of course. For sure, this is a well-embraced bull market, with full investor allocations to stocks and very low short interest. Yet tactical indicators are more moderate, as brief shakeouts and whippy rotations keep traders off balance and the sped-up, amplified economic cycle drives an unfamiliarly wide range of plausible outcomes for GDP growth, inflation and Fed reactions. Enthusiasm in check Bank of America's Bull & Bear Indicator has rolled over without pushing into the danger zone of aggressive optimism and heedless risk-taking. It now sits in the zone that prevailed in the 2013-14 period, when the bull market was in a steady grind rather than a full gallop. Wall Street pros are keeping expectations in check, mostly. Brokerage-house strategists' consensus S & P 500 target for the end of the year has already been reached. FactSet's John Butters tracks the implied S & P 500 target derived from all the individual share-price targets of sell-side analysts. Currently, if the median 12-month target for each S & P 500 stock were reached, the S & P 500 would be at 4803 in a year, up 9.9% from Friday's close. That's a pretty reserved aggregate outlook: Butters says the five-year average upside implied target is 11.7%, the ten-year 12.3% and 15-year 14.5%. Could this mean that stocks have run so high that even Wall Street analysts don't see them gaining much more? Possibly. But over the past five years analysts have slightly underestimated stock performance, by this gauge, says Butters. And on June 30, 2020, analysts projected less than 8% upside; the S & P surged 38% over the next year. The absence of unbridled enthusiasm alone is not a guarantee that the market will keep clicking higher without nasty switchbacks, of course. The S & P 500 is just a third of a percent short of having doubled from the March 2020 low less than 16 months ago. Just because "everybody knows" the market is up a ton and the second year of a bull market is usually choppier and less generous doesn't mean those facts aren't relevant. The unimpressive breadth of the recent rally might be universally acknowledged and fretted over, but that doesn't turn it into a positive. The calendar is a secret to no one, yet all the same, mid-July into September has undeniably been a less-rewarding period for equities over the decades. Earnings for the second quarter are about to be revealed as jumping more than 60% from a year ago, and rising full-year estimates have pulled down the S & P 500's valuation. That doesn't make stocks cheap or immune to "sell the news" responses to great results, though. Still, in a sturdy if maturing bull market — with inflation-adjusted bond yields negative, companies brimming with cash and consumers sitting on extraordinary latent spending power – it's better to have such nagging concerns out in the open to form a healthy wall of worry than ignored by an unquestioning upbeat consensus.

Traders on the floor of the New York Stock Exchange

Source: NYSE

The shadow of doubt has kept the stock market from overheating all year.