History suggests near-term consolidation, but a positive prognosis for the stock market over the intermediate term. Of concern was the deteriorating market breadth since mid-April. Most divergences resolve themselves to the upside; however, some do turn into cyclical peaks.
A complicating factor is the massive stock offerings in the area most responsible for recent gains – Technology/AI – increase the risk of a pullback in the cap-weighted benchmarks heading into the fourth quarter. From a technical perspective, we will be watching to see if any pullbacks in recent leaders are healthy rotations into previous laggards or a continued narrowing more reflective of a bull market top. More broadly, we will be watching to see if a reduction from our overweight exposure to U.S. stocks versus bonds and cash is warranted.
Put aside the downdraft on chips and related stocks and look at the overall economy and what is really happening in boardrooms. They have become much more settled, realistic and optimistic about investing, M&A, and growth. M&A this year will possibly hit a record, IPO’s will be far above anything ever seen in history, expansions of production facilities are now being invested well beyond data centers. Although there is this historic flood of new capital into the stock market with mega IPO’s, $250 billion of stock value has come out due to companies being taken private. The capital markets are booming as companies are looking past Iran, oil and fertilizer prices, a bump up in inflation, and the elections, and betting huge on future growth.
While inflation remains higher, if you strip out energy and food the real number is 2.9% core. Not really high. Once gas prices return to their prior level, CPI returns under 3%. The Fed is likely to just do nothing for several months. This then removes the fears of the unknown of the new Fed Chair Warsh. He says he is going to use a different set of metrics to evaluate the economy and how the Fed should act, but it appears that the markets may have already adapted to this. Despite all that is happening and higher oil prices, the US economy is powering ahead and growing very well. Most importantly, jobs are being created and wages are rising a little faster than inflation. While the lower income cohort is pressed due to inflation of gas prices, and to some extent food prices, consumers are still spending well, so the economy will continue to do well. We have no idea at all what comes next with Iran so projecting when gas prices will fall is not possible now. But it will likely happen late this summer, we just do not know when.
There is believed to be round $7 Trillion of cash potentially available to go into the stock market, sitting in money funds and other liquid accounts. Even if only some of that comes into the stock market it will make a good upside difference. A sizable chunk will go to the new IPO’s. The US continues to be the world dominant economy, and the most liquid securities markets, so while some investment capital has migrated to emerging markets, even to Europe, that capital is not so great as to cause a material flow out of the US.
The rest of the analysis walks through studies and indicators to watch heading into the second half. Two Fridays ago, the S&P 500 tumbled 2.6%, its worst day since October 10, 2025. The plunge also ended a nine-week winning streak for the benchmark, which tied for the sixth longest since 1928 and fourth longest since WWII. The table below shows the S&P 500 around previous nine-week streaks.
The first interesting stat is that the 19.0% gain in the nine weeks ending May 29 is the highest in the table, confirming other studies that the rally over the past two months is one for the record books. Second, returns over the near term have been mixed. Few nine-week streaks survive a tenth week. The market has tended to recover quickly, however. Since 1946, four weeks later, the S&P 500 has been higher 82% of the time. The gains have tended to continue. Six months later, the S&P 500 has been higher 73% of the time by a median of 8.2%, nearly double its long-term average. Returns one year later have been above average, although the mean and median are not much higher than over any 52-week period.
The Friday drop spawned another question: what has happened if big rallies have been followed by sharp reversals?. The table below shows all cases when the S&P 500 has risen by at least 15% in 50 trading days and then experienced a single day decline of at least 2% within trading 21 days (one month). The list is short, with June 5 being the fifth case since 1928 and the third post-war. Subsequent returns were positive, especially in the two previous post-war cases.
The final table expands the window to 42 trading days (two months) for a 2% down day. The returns are similar to the nine-week winning streak study above. After some consolidation – this time returns one-month later are below average – the S&P 500 has posted above average, but not spectacular, returns six and 12 months later. The lower means versus the medians reflect the fact that study captures some major bear markets like the 1987 crash and the final down leg of the 2002 cyclical bear. This is the tail end of the Dot Com Bubble. Our conclusion from the studies is that the more likely outcome is a period of consolidation before a resumption of the uptrend, but that a blow off top cannot be dismissed.
The massive offering that occurred last week was not only historic, but attention grabbing. I will say that this has generated perhaps the highest interest I have seen in over 20 years from investors, dogs, cats, and grandparents! When I’m in a public place and people hear that I’m involved professionally in the stock market, there has been no hesitation in asking my opinion. I will say that it is difficult to explain my answer when it encompasses not just an opinion of the company but also the impact it is having on the weighting and make up of the indexes. This is truly historic and could be repeated by the other large offerings that could be slated to occur in the second half of this year.
One item that due to the hype of the war, oil, IPO’s and other anxiety generating events is the underlying health of the overall US stock market. If we are to look at where the market currently sits on an earnings basis, the rise in prices has done little to make the markets more expensive. Notably, although we are already on our 7th black-swan event since 2020 (the U.S.-Iran war), the P/E of the S&P 500 on an equal-weighted basis is still below where it was in 2019. If you had put a company to a test like this and it survived without any meaningful earnings decline, we would say that its multiple needs to go up. Similarly, our view for the S&P 500 as a whole is that the multiple should go higher, in contrast to concerns about high valuations that skeptics have voiced after the recent rally.
We are entering the dog days of summer. Normally, this is a time that market activity slows down, and people try and either enjoy summer with their kids or at least stay in from the heat. Well, doesn’t quite feel like that in the markets that’s for sure! According to many cycle studies and seasonal data we are destined for some type of correction period in the August / September time period, but if the valuation chart above is truly the case, the $7 Trillion on the sideline will continue to be deployed and the markets could exhibit this phase as a flat spot rather than a decline of any substance. I believe that baring some large exogenous event, basically everything is in place for a continuation of the current market advance.
-Ken South, Tower 68 Financial Advisors, Newport Beach
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