A Recovery or Relief Rally in Stocks?

September is living up to its reputation as a historically bad month for stocks. The S&P 500 fell 2.3% in the first two trading days, with a highly anticipated August employment report on deck tomorrow morning. The sudden change in momentum and jump in volatility has left many investors questioning the sustainability of the recovery from the August lows and if the rebound was simply a relief rally off oversold levels.

As highlighted below, August was a wild month for stocks. The S&P 500 sank over 8% in 14 trading days before finally hitting an intraday low of 5,119 on August 5. That week was primarily plagued by the unwinding of the yen-carry trade, weak manufacturing data, and a disappointing employment report. As economic data improved and currency market volatility subsided, stocks pared losses with an impressive rebound. However, the recovery fell just short of retesting the prior July highs. It was also underpinned by below-average volume and a surge in retail buying based on changes in U.S. equity market positioning.

And while market breadth metrics remain constructive, participation in more defensive areas of the market has supported the broadening-out theme. Technology, the S&P 500’s biggest sector weight at 30%, has been a source of capital for the rotation and is close to confirming a top in relative terms to the broader market — technically, a close below the August lows on the sector vs. S&P 500 would imply a top has been made.

Where do stocks go from here? Recent technical damage and momentum indicators point to elevated downside risk ahead. Support sets up at the 20- and 50-day moving averages (5,518 and 5,506, respectively), followed by a price gap at 5,455 and the August lows at 5,119. In the event of a rally, resistance for the S&P 500 comes into play at the August and July highs at 5,648 and 5,667, respectively.

S&P 500 Recovery Stalls Just Shy of the July High

Source: LPL Research, Bloomberg 09/05/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.

A Closer Peek at the Recovery

One of the more surprising factors in the volatility over the last month has been how quickly stocks fell and recovered. The drop of over 8% in 14 trading days into the August 5 low was quickly followed by an 8% rebound in the same number of trading days. This created a so-called “V-shaped” recovery for the broader market, which is rare but not unprecedented. Since 1950, we found only 15 other occurrences with comparable drawdowns and recoveries over this short period. Historically, forward returns after the S&P 500 rallied back at least 8% in 14 days (after being down at least 8% in 14 days) have been constructive over the following three- to 12-month period. Furthermore, 93% of occurrences produced positive returns 12 months later.

The strong performance leading into the recent V-shaped recovery in August was notable. It marked the only period with a positive six-month return and one of only two periods with a positive three-month return before the V-shape was completed.

S&P 500 Performance Before and After a V-Shaped Recovery

Source: LPL Research, Bloomberg 09/05/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.

Summary

September is off to a weak start as the recovery on the S&P 500 stalled near resistance from the July highs. Momentum indicators have turned bearish, and signs of defensive leadership have begun to emerge, pointing to more volatility ahead. Breakdowns in longer-duration Treasury yields, crude oil, and copper, along with a simultaneous breakout in gold, provide a warning sign of rising risks to an economic soft landing.

LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its neutral stance on equities. We expect volatility to remain elevated over the next few months, and believe a better entry point back into the longer-term bull market is likely.