The S&P 500 plunged -4.25% this week with Friday's close at 5,408.42. The index opened lower to start the week, and the weekly open recorded as the weekly high, so the price action this week was all downhill, literally.
The S&P 500 traded lower each and every day Tuesday through Friday, with the index falling -2.11% on Tuesday and -1.73% on Friday. We've used a football analogy each of our last few Updates illustrating how the S&P 500 was knocking on the door of the end zone, retesting all-time highs and in position to "score" or break out to the upside. Well, if it was 1st-and- goal at the 1-yard line last Sunday, then we got a holding penalty this past week. Back it up 10 yards, S&P 500.
This week's move lower perpetuates the trading range we discussed in our Update from August 11:
"Trading ranges are notoriously difficult to forecast, mostly because any and all price action confined within the range always comes with a "yea, but..." or an asterisk. In other words, the S&P 500 can't resume a primary uptrend on its daily chart until the index breaks out to new all-time highs above the ~5,670 level (solid red line), and the world can't go back to ending like it was on Monday until the S&P 500 breaks down below the ~5,119 level (solid blue line).
The price action confined between these two levels is noise, not signal, no matter how loud the noises get. Should the S&P 500 trade all the way back to the ~5,500 level this week, we'll still say "yea, but...". A "retest" has to happen, no matter whether it's retesting this week's low in the 5,100s or retesting our all-time highs in the 5,600s. The market can't receive a pass or fail grade until the test occurs! Now, with the Volatility Index (VIX) finishing the week at 20.37 the S&P 500 is still expected to move up/down by more than 1% on a daily basis, so the expected price action inside the range is likely going to be wild. Naturally, the seat belt light remains on."
Clearly the first retest of our all-time highs received a failing grade.
However, this week's downside reversal doesn't mean we can't retake the test at some point in the future, and it doesn't mean we're destined to break down below support in the low 5,100s either.
This week's downside reversal leaves the S&P 500 in no-man's-land, squarely back in the middle of the range, meaning the price action from here reverts to being viewed as noise, not signal. We're back to "yea, but..." until we take our next test, no matter whether that's retesting our all-time highs in the 5,600s or our recent swing low in the 5,100s. Should we kick off next week moving back to the north, perhaps trading back toward the ~5,500 level, we'll say "yea, but...". If we find negative momentum into tomorrow, perhaps trading down into the ~5,300s, we'll say "yea, but...".
The main point is the S&P 500 is stuck, consolidating and correcting through time, which is natural, normal and healthy given the index's trailing returns the last 12 and 24 months, which currently sit at 26.13% and 50.84% respectively.
We continue to believe we have a strong fourth quarter year-end rally in our future, but we're not in the fourth quarter yet!
Fundamentally, the picture is a bit cloudy at the moment. The labor market continues to show some cracks (click here), Friday's jobs report didn't exactly stem concerns regarding the unintended consequences excessively tight monetary policy is having on the labor market. With the Fed ready to pivot but there still being uncertainty as to the size of the first rate cut on 9/18 (i.e., -0.25% or -.50%), the market seems to be struggling to discount whether or not the Fed's pivot is arriving a few minutes late or a few hours late.
If the bond market could speak it would be screaming at the Fed to cut rates.
Yields on the short end of the curve have absolutely plunged over the last two months. The yield on a 1-year Treasury bond closed Friday at 4.09%...it was above 5% in early July! The yield on a 2-year Treasury bond, often viewed as the best proxy for where the federal funds rate should be set, closed Friday at 3.65%. That implies the Fed is too tight by more than 1.50%! The bond market appears to have conviction that the Fed is behind the curve and that's why bond prices are surging in the present, helping balanced and diversified portfolios outperform during recent equity market weakness.
Market internals have an decidedly "defensive" tone of late too.
Consumer staples, real estate and utilities all outperformed this week and have been three of the top four performing sectors within the S&P 500 over the last three months. Meanwhile, the technology sector has been the worst performing sector within the S&P 500 the last three months, falling -5.05%.
This has helped market breadth in the sense that more broad and balanced indices have outperformed; the S&P 500 Equal Weight Index (SPXEW) is higher by more than 4% over the last 12 weeks while the S&P 500 itself is negative over the same time span. But improving market breadth at the expense of weakness from the biggest and most influential sectors is not a great trade. It's like the Lakers' role players catching fire while Lebron James goes ice cold - they're not going to win many games!
As for the week ahead, we'll get inflation data on Wednesday and Thursday and we're not expecting anything "hot". It will be interesting to see how the market trades if we do get more relatively "cool" inflation data. Once upon a time we'd write that the Fed's primary mandate is to "inflate or die", which was tongue-in-cheek about how the Fed will generally do whatever it takes to avoid a deflationary wave putting a stranglehold on the economy.
S&P 500 Primary Trend - Up
Our work continues to label the primary trend as up, or bullish. During uptrends, investors are generally best served maintaining an equity overweight across their asset allocation and relying mostly on passive investing methodologies. It's not until the primary trend can be labeled down, or bearish, where investors should "rebalance" their portfolio in an effort to manage the risks associated with a "bear market" for the S&P 500. Following a plan of this nature will provide investors a method to identify whatever pitch the market throws, whether it's a fastball down the middle (uptrends) or a nasty 12-6 curveball (downtrends), and adjust their swing accordingly.
Since breaking out to the upside in July, the S&P 500 has been consolidating and mostly trading sideways. We've used this analogy a lot over the years, but given the sprint higher the S&P 500 embarked on from April's bottom up into July's peak near ~5,700, the index needed to catch its breath.
Back in July we wrote:
"We can all now draw a horizontal line across the 5,667.20 level. This is the highest daily close in the history of the S&P 500 and it's where "resistance" revealed itself. From a retracement perspective, we'd love to see the S&P 500 trade down into the 5,300s, but ideally not next week. Consolidating between ~5,300 and ~5,700 over the remainder of the third quarter would be ideal."
We're essentially there - the S&P 500 has been consolidating almost all of the third quarter.
We think the S&P 500's battery is almost recharged. Simply put, we think the S&P 500's consolidation the last two months is healthy regarding the outlook for the remainder of 2024.
As for the fourth quarter of 2024, it's very rare for calendar years that demonstrate this much strength through the first eight months of the year to simply fall flat on their face the remainder of the year.
Reference back to the table we shared in last week's Update.
As always, long-term investors have to decide what risks they're willing to accept across their portfolio. Broadly speaking, it boils down to the decision to risk money (i.e., invest in something that's not principally protected in exchange for potential meaningful return on investment) or risk opportunity (i.e., invest in something that is principally protected and lose the potential to earn meaningful return on investment).
The easy decision as of today is to "take the money and run" - it's easy to want to sell it all and hang out in short-term Treasury bills paying 4% per year interest. It's much harder to hang in there and have faith in the idea of a strong fourth quarter. In the investing world, and life in general, it's the harder path that's typically more rewarding!
Happy Sunday!
Steve & Rick