The summer has a reputation for slow, boring stock market action. That may sometimes be the case, but on average the period beginning right about now has historically been very kind to investors. Not only is this week typically one of the best of the year, but it also kicks off one of the better stretches on the calendar up until the middle of September. As I always qualify anytime I discuss seasonality, it should only act as a general guide rather than a guarantee. We still must respect the price action, though history does suggest the window is there to continue the rally. Here is what the statistics show for this week and then for the month that next 3 months:
To put it into a broader context, I took the last 20 years and added every year together with the next one to maybe get a clue as to what the year could look like and more specifically, as is the reason for authoring this note, I want to get a bit of a closer look at the month of July. I have circled in yellow the chart action for July:
July has been the best month for the S&P 500 over the past 20 years. 80% of the time the index has closed higher than it began the month, and the average gain of 2.54% is the highest of any month. Again, we cannot assume it will definitely finish higher this time, but the opportunity is certainly there. It should also be remembered that this takes into account a lot of black swans, and many different types of Presidential administrations.
The fear backdrop that has begun to develop over the last couple of weeks tends to set up the month quite nicely as well. The S&P 500 gained a net 1.75% in the holiday shortened week but only 49.35% of NYSE operating companies advanced each session, on average. The week before, the S&P 500 lost 1.97%, yet 60.68% of NYSE operating companies advanced each day, illustrating the peculiarities occurring underneath the market’s surface. This may not seem particularly important to many, but I see it as a manifestation of the generals taking their well-deserved rest and the troops getting their days in the sun. Hence, the reason why you had a larger percentage of companies advancing yet the index was down. If the generals (which have a larger vote due to the cap weighted nature of the indexes) have a tough time of it, others can rally but on the surface it isn’t recognizable.
What will be interesting to see moving forward is if the troops can continue their advance and if the generals will get back on their horses as well. This is a tough one to tell, and not really something that can be discussed with certainty due to statistical history. What we do know is that the generals are acting “different this time” as they are advancing with true earnings underneath them to support their price advances where technology problems from the past were due to hopes and dreams of companies being profitable. Unfortunately, companies became overvalued and this became unsupportable and was therefore followed by the elevator-like decline. This time, as I wrote last week, the P/E ratios of the market leaders have declined as their prices have advanced due to earnings advancing even quicker!
Besides the never-ending argument relative to valuations, the issue being bantered about today is about the amount of money being invested with the use of margins. This is considered very speculative as it is investors borrowing and leveraging their portfolios to fund additional purchases of securities. Here is the chart of the current level of margin debt:
I can clearly understand the graphic nature of this record setting level of debt on portfolios, but I instead choose to look at things a bit differently. Instead, I prefer to look at debt from the perspective of fear of credit quality. What I mean by this is if the institutional investor is concerned about the status of the economy and therefore an overabundance of bad or junk debt being funded, the credit spread between high quality debt and low quality or risky debt should expand. We are currently at the lowest spread seen in some time. This would tend to infer that the expectations for the economy is for broad and expanding quality of businesses and the debt they are incurring to fund their expansion. Here is the chart:
Notice that spikes, or higher spreads occurred during major market dislocations. But when the equity markets are healthy and continuing their advance, the spreads remain tight and defaults remained low.
The next upcoming fly in the ointment is the unknown of the new Fed Chair Warsh’s actions to thwart inflation. The talk is that he could raise interest rates sometime between now and the September Fed meeting. Is this because of inflation caused by high oil prices or is it because of the economy hitting on all cylinders and therefore moving to a overly ebullient growth level? This is a great and as yet not answerable question. This could also be why Thomas Lee of FundStrat Direct feels that the markets could trade at higher highs in the short run but that the August-October time period could by uncomfortably negative.
The S&P 500 has done well historically after a first rate hike when it was not the start of a new tightening cycle. If Kevin Warsh and the Fed can continue to keep longer-term inflation expectations anchored lower, our longer-term interest rate indicators should start turning more constructive on stocks. Stock investors appear to be looking past any projected hike for now. This might change as we get closer to the midterm election hysteria. The newspapers are already banging this drum pretty hard and if this midterm issue coupled with interest rates reflecting a greater probability of higher rates, this could put a lid on the current advance for at least a bit.
At present, interest rates remain locked in the range they have been in since 2025. The credit spread between high quality and junk debt continues to have no hint of credit issues. And the earnings forecasts have continued to progress across many industries. This speaks to broadening economic stability. Corrections always happen for a different set of reasons, and we will do all we can to keep you informed as to what we are seeing should an unfriendly combination of facts develop.
-Ken South, Tower 68 Financial Advisors, Newport Beach
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