‘Psychology has changed so quickly’: Why stock market lows may be retested as the S&P 500 enters its weakest period of the year

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With summer winding down, the US stock market is poised for a potentially fragile fall.

“Recession fears are the most likely trigger for a retest of June lows,” Ed Clissold, chief U.S. strategist at Ned Davis Research, said in an Aug. 31 note. “From a seasonality point of view, a new test could take place in the next few weeks.”

When U.S. investors return from the Labor Day long weekend, history indicates they will face the weakest time of the year for the S&P 500: the period from September 6 to October 25. , according to the note.

NED DAVIS RESEARCH REPORT DATED AUGUST. July 31, 2022


The stock market is already shaky.

U.S. stocks closed sharply lower on Friday, with all three major benchmarks suffering a third consecutive week of losses. However, the S&P 500 SPX,
-1.07%
ended 7% above its 52-week low of 3666.77 on June 16, according to Dow Jones Market Data.

“I think we need to go back and test that level,” Bob Doll, chief investment officer of Crossmark Global Investments, said in a phone interview. “I don’t think the bear market is necessarily over,” he said, although “what I don’t see is a massive decline from here.”

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Meanwhile, continued interest rate hikes by the Federal Reserve to combat soaring inflation in a slowing U.S. economy raise the odds of a recession, as well as the prospect of retesting stock market lows this year, according to Ned Davis’ note. This year, the Fed has “committed to removing liquidity from the financial system,” making a retest more likely, Clissold wrote.

Vanguard Group said in a Sept. 1 report that it had lowered its forecast for U.S. economic growth this year after two straight quarters of contraction. The company now expects economic growth of 0.25% to 0.75% for the year 2022, down from its estimate of around 1.5% last month.

“We think it’s likely that the United States will struggle to return to above-trend growth in the coming quarters,” Vanguard said. “We put the probability of a US recession at around 25% over the next 12 months and 65% over the next 24 months.”

According to Ned Davis, whether a “retest” of stock market lows is brief will depend on the ability of the United States to avoid a recession.

“The average recession-free bear lasts about seven months and has declined 25% (-18% over the past half-century), putting the January-June decline in line with the typical case,” Clissold wrote in the note by Ned Davis. “Conversely, the average recession lasted about a year (17 months over the past 50 years) and shrunk by an average of 35%.”

The Inflation “Dragon”

Investors expected another big interest rate hike from the Fed at its September 20-21 meeting, after Chairman Jerome Powell sent a clear message in his Jackson Hole speech on September 26. August that the central bank would continue to fight high inflation until the job was done – even if it meant some pain for households and businesses.

Stocks slumped at his remarks that day, with the Dow Jones Industrial Average DJIA,
-1.07%
closed 1,000 points and the losses have worsened since then.

The “vigorous” rally in stocks seen earlier in the summer had reflected “too much optimism given that we are still in the early stages of fighting inflation,” Crossmark’s Doll said. Although he thinks inflation has peaked, Doll predicts its continued decline this year will likely be erratic and end 2022 above the Fed’s 2% target.

“Isn’t it going to end up at a level where we’re like, ‘ok, we’ve got this dragon, so what’?” he said. If inflation, which reached 9.1% in June based on the consumer price index, drops to 4% or 5%, “that’s good news, but it’s not enough to say the Fed is done,” Doll said.

Vanguard expects the Fed to raise its federal funds rate target to a range of 3.25% to 3.75% by the end of the year, from near zero at the start of 2022, according to his grade. This compares to a current range of 2.25% to 2.5%.

Prior to Powell’s speech in Jackson Hole, the market narrative had moved away from the Fed fighting inflation with aggressive rate hikes to asking “when will they pivot?” said Steve Sosnick, chief strategist at Interactive Brokers. But using a relatively short speech, which had “no ambiguity”, Powell brought the focus back to monetary tightening and the Fed’s unfinished fight against inflation, sending “a very powerful message to the market”, said Sosnick said.

“We’ve been dealing with this ever since,” he said, pointing to the stock market losses.

“The fact that we’ve moved so far so fast and the psychology has changed so quickly makes me think we’re a long way from seeing the end of volatility, especially in the fall,” Sosnick said. “The September to October period definitely gets more than its fair share of market weirdness.”

The bottom of the stock market?

Equity and quantitative strategists at Bank of America said in a Sept. 2 note from BofA Global Research that S&P 500 valuations remain “rich.” In their opinion, “a bottom is not in it.”

“Initially, the rally from the June lows looked more like a young cyclical bullish than a bearish rally,” Clissold said, in the note by Ned Davis. “Multiple breakouts of magnitude and new expanding highs suggest much of the decline has run its course.”

But medium- to long-term momentum needed to follow to confirm a bull market, he said, and without that confirmation, “a retest cannot be ruled out.”

“The S&P 500 stalled just below its declining 200-day moving average and gave up about half of its gains from June 16 through August 16,” Clissold wrote. Additionally, “the percentage of stocks above their 50-day moving averages just crossed its 90% threshold.”

US stocks ended Friday with weekly losses, with the S&P 500 SPX,
-1.07%
losing 3.3% while the Dow Jones Industrial Average DJIA,
-1.07%
fell 3% and the technology-heavy Nasdaq Composite COMP,
-1.31%
fell 4.2%.

The U.S. stock market will take a break on Monday to celebrate Labor Day and resume trading on Tuesday. The economic calendar for the week ahead includes data on U.S. services, unemployment insurance claims and consumer credit, as well as the release of the Fed’s ‘beige book’, which includes a collection of trivia trade across the country.

The Fed’s pursuit of aggressive rate hikes combined with the coming weakness in corporate earnings and the labor market “is not a strong backdrop for the equity market,” said Liz Ann Sonders, strategist Liz Ann Sonders. chief investment officer at Charles Schwab, by phone. Additionally, “we know September, seasonally, tends to be a weak month” for stocks.

Hear Carl Icahn at the Best New Ideas in Money Festival on September 21-22 in New York City. The legendary trader will reveal his take on this year’s market madness.

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