Why Veteran Market Technicians Are Worried About The Summer Stock Rally

Summer temperatures are rising and so is the stock market. After 164 days, the S&P 500 Index crossed officially back into bull market territory, given the 23% rise from its October lows. Only the recovery in 1947 from bear market bottom to new bull market took longer, at 281 days. Last week the Bureau of Labor Statistics announced inflation had cooled to 4%, the lowest reading in two years, and on June 14, Federal Reserve Chairman Jerome Powell announced interest rates would not increase – pausing the rate hike after an aggressive 15 months.

The combination of factors could point to a strong summer for the markets, however several market veterans are warning that the current bull run could be little more than a head-fake.

“If this is indeed a new bull market, it is undoubtedly one of the most unusual in Wall Street history,” says veteran market technician Jim Stack in the most recent edition of his InvesTech Research newsletter.

According to Stack’s analysis, the Russell 2000, which includes the smallest market cap stocks, typically leads with the largest gains in a new bull market. In the past 40 years, the index has typically gained 30%, eight months into a new bull market, but today, the index sits up only about 13% from its October lows.

Additionally, InvesTech found that the top 10 stocks including Apple
AAPL
, Tesla
TSLA
, and Amazon
AMZN
in the S&P 500 disproportionately made up 81% of the S&P’s year to date gain. There is a concentration in large cap stocks and a divergence from small cap stocks that create an unhealthy bull market, according to CEO Jim Stack.

“We’re in uncharted territory,” says Stack.

In 2007, the markets had similar occurrences prior to the financial crisis. Stack is not predicting another crisis, but said this summer’s macro economic and technical indicators point to a riskier environment for investors.

Even the Fed’s “hawkish pause” on interest rates is a cause of concern for InvesTech. Inflation is softening, but the Fed prefers to measure inflation through the Core Personal Consumption Expenditure Price Index (PCE), a measure of goods and services minus energy and food. The index remains over double the Fed’s target inflation rate of 2%, signaling the Fed is far from over playing with interest rates.

The Federal Reserve’s Yield Spread Model, measuring the distance between short term and long term treasury yields, has historically been a model that has predicted recessions. InvesTech’s analysis said the model shows a 71% probability of a recession.

The Conference Board Leading Economic Index (LEI), another indicator for a looming or present recession, has also fallen for 13 months, creating a stronger case for a recession.

“The LEI hasn’t fallen by this amount without the U.S. economy going into recession,” Stack said.

Stack added that longer bear markets tend to include smaller bull markets. At the height of the Great Depression from 1929 to 1932, there were five bull markets. During the tech bubble in 2000, there were two bull markets by Wall Street standards.

According to market technician Jeff Hirsh, editor-in-chief of the 55-year old Stock Trader’s Almanac, the current bull market is hitting a weaker seasonal pattern, contrary to the ‘summer rally’ phenomena. According to Hirsch, a summer rally is defined as the lowest close in the Dow Jones Industrials in May or June to the highest close 60 to 90 days later. But a summer rally is a mythical trend, says Hirsch.

From May to June, the Dow Jones Industrial Average has traditionally had the smallest rallies on average since 1962 before regaining its footing in September, according to data provided by InvesTech Research. In other research provided by InvesTech, if one person invested $10,000 dollars from November 1 to April 30, the individual could see over $970,000 more in returns compared to an individual who invested the same amount from May 1 to October 31.

David Keller, Chief Market Strategist at StockCharts.com, called a strong start to June “abnormal” because June is historically one of the worst performing months. However, Keller pointed out that the S&P 500 was overbought this week after the bullish news, and traditionally overbuying means a drawing a close on a bull market.

“Many leadership names like AAPL and MSFT are testing all-time highs, and given the strength in performance thus far in 2023 they are certainly due for a meaningful pullback,” Keller said in a statement provided to Forbes.

In 2022, there was a mid-July peak and Hirsh suspects investors will see a similar trend this year. However, by August and September as the Fed reevaluates interest rates, Hirsh expects the market to pull back.

Historically, the summer months bring market dips as people take a vacation from investing and their work life, according to Hirsh. By the fall, investors have readjusted their strategy and companies prepare to release third quarter results.

InvesTech warns investors to proceed with caution through the summer and to remember “the best offense is still a good defense.”

Hirsh suggests enjoying the summer months and holding stocks that are performing well like healthcare and biotech. Otherwise, he said take a page out of the Fed’s book and pause: restrategize for the fall, enjoy the summer weather, and build up your reserves.

“Those who understand market history are bound to profit from it,” says Hirsh.