With U.S. stocks rebounding, this summer’s slide looks more like a pause in a bull market than the beginning of its end. Here are six reasons why.
A contained decline
Of course, traders have had a hard time predicting where the economy is headed, and the recession fears that contributed to the recent downturn could resurface as quickly as they faded. In addition, the U.S. election and geopolitical tensions add further elements of uncertainty.
But beneath the surface, there are some reassuring signals. Among them: The selloff has affected a relatively small portion of the market, not comparable to the routs triggered by the Federal Reserve’s rate hikes, the pandemic and other major events. And while valuations are likely to recalibrate again if the economy eventually runs out of steam, the S&P 500 has held above a threshold during the recent selloff that, to technical analysts at least, indicates that investors remain confident.
Moreover, the benchmark index has already recovered all of its August decline and is now just 2.2% from its mid-July record high.
Few titles affected
While the fall that began last month was sharp and rapid, sending the tech-heavy NASDAQ-100 Index into a technical correction in three weeks, it was driven by a small number of stocks.
Only about 5% of the S&P 500 index fell to its lowest level in a year, according to data compiled by Bloomberg. That means the decline was much more limited in scope than previous ones triggered by major macroeconomic shifts. After a surge in inflation prompted the Fed to aggressively raise rates in 2022, nearly half of the index fell to its lowest level in 12 months. The pandemic has pushed about two-thirds of the index to that level.
A limited decline
Before last month, the S&P 500 had its longest stretch without a 2% one-day decline since the start of the global financial crisis in 2007. From one perspective, that makes the reset seem overdue.
Unlike the NASDAQ-100, whose slide reflected long-simmering concerns about tech companies’ sky-high valuations, the S&P 500 never formally fell into correction, rebounding after falling 8.5% from its peak.
In 2022, the index fell 25% before making a sustained rebound. And during the 2007-08 financial crisis, it plunged 57%, then took four years to fully recover.
Above key levels
The S&P 500’s 200-week moving average has been a strong indicator of the index’s bottom since the turn of the century. More recently, the benchmark index has rebounded after hitting it during the economic growth slump in 2016, the U.S.-China trade war in 2018 and again in 2022.
This time, it fell far short of that threshold, even at its lowest point. While this also indicates how far the index could collapse if it fell again, it shows that investors were confident enough to step in well before the market tested a new low.
Japan bounces back
Japan has been at the centre of the recent turmoil after its tightening monetary policy sent the yen to one of its highest levels of the year, prompting hedge funds to sell assets to unwind carry trades financed by cheap loans to Japan.
The currency is now easing again as Japanese policymakers quickly reassured markets that further rate hikes were unlikely to be on the cards. That has also had a positive impact on Japanese stocks.
Signs to watch for
On the other hand, the economic risk that the Fed waited too long to start cutting rates has not gone away. The recent rebound therefore means that investors are increasingly banking on a soft landing for the economy, which would expose the market to further decline if that assumption proves wrong.
How stocks tied to the economic cycle – or so-called cyclical sectors – perform relative to their less exposed counterparts is a measure of what investors are counting on.
In the US, a Goldman Sachs Group assessment, which measures relative performance across equity groups, shows that while cyclical sectors have recently been outpaced by defensive sectors, they are still valued based on economic expansion.
On Thursday, an unexpected jump in retail sales supported that view. But previous figures have also pointed to slowing job growth and a decline in manufacturing activity.
“I’m not hitting the panic button by any means, but compared to other asset classes, the S&P 500 seems to have priced in very little uncertainty,” said Matt Stucky, chief equity portfolio manager at Northwestern Mutual Wealth Management.