U.S. Stock Market Poised for a Shift in Momentum

The remarkable performance of the U.S. stock market in 2023 has positioned the S&P 500 index at a critical juncture, signaling a potentially more turbulent second half of the year, according to Ed Clissold, chief U.S. strategist at Ned Davis Research.

With a staggering 19.5% gain through July, the S&P 500 has witnessed its strongest seven-month stretch since 1997. This rally has brought the market to a tipping point in terms of momentum and mean reversion, as highlighted by Clissold in a note issued on August 2.

To gain insights into possible outcomes, Clissold examined historical data on previous instances when the S&P 500 recorded a minimum of 15% gains during the first seven months of a year. His analysis revealed that "over the last five months of the year, the index rose 86.4% of the time by a median of 7.0%."

Despite these statistics, Clissold emphasized the importance of remaining cautious, stating, "For now, we are maintaining our overweight to stocks in our U.S. asset allocation." Nevertheless, he noted that mean reversion becomes more likely if year-to-date gains exceed 20%.

Clissold acknowledged that his findings offer only a partial glimpse into the future trajectory of each year following such significant gains. Factors such as "blowoff tops, recessions, wars, Fed cycles, and other macro drivers" ultimately determine whether the market's positive momentum endures.

However, Clissold's research indicates that, in most cases, the S&P 500 loses steam over the last five months of the year. "Strong starts to the year are followed by smaller gains the rest of the year, on average," he stated. Only once in history did the S&P 500 surpass its pre-July gains in the remaining months of the year, and that occurred in 1935.

As investors navigate the market landscape, Clissold's insights serve as a reminder of the potential shifts that lie ahead, urging prudent decision-making and measured expectations in the face of evolving market dynamics.

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The S&P 500 has experienced a 1.6% decline in August, with Wednesday witnessing a significant 1.3% drop. However, despite the Federal Reserve’s interest-rate hiking campaign launched in early 2022, the market is still up 17.6% for the year, demonstrating the resilience of the economy.

Giant Wealth Transfer Explains Ineffectiveness of Fed Policy

On Thursday afternoon, major U.S. stock indexes showed modest gains as investors evaluated recent economic data, which indicated a slight increase in initial jobless claims and labor productivity during Q2. According to FactSet data, the Dow Jones Industrial Average (DJIA) rose by 0.1%, the S&P 500 (SPX) saw an increase below 0.1%, and the Nasdaq Composite (COMP) gained 0.3%.

While the Federal Reserve has been implementing tighter monetary policies in an attempt to curb high inflation rates, the unemployment rate has remained relatively low in the United States.

Anticipation of Slower Rate Hikes Fuels Bull Market

According to Clissold, last year's equity bear market was primarily caused by the most aggressive tightening cycle in at least 40 years. However, this year's bull market has been driven by the expectation of a slower pace of rate hikes and an eventual end to the tightening cycle.