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Portfolio > Economy & Markets

S&P 500 Rally Hits a Wall at End of Banner Quarter

By Rita Nazareth

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What You Need to Know

  • Stocks are heading into the second half having gained about 15% this year.
  • The S&P 500 has followed up a positive first-half return with an average second-half gain of 6%.
  • Softening in the measure of inflation favored by the Fed highlights a slowing economy that’s upping the risk of a policy error by the central bank, Mohamed El-Erian said.

Wall Street’s enthusiasm faded in the final stretch of a solid quarter for stocks that saw the market hitting multiple all-time highs.

The S&P 500 was little changed after gaining almost 1% earlier Friday. The Nasdaq 100 also lost steam after briefly surpassing 20,000 amid volatility in big techs.

Treasury yields pushed higher, reversing a drop in the immediate aftermath of inflation data that bolstered bets on Federal Reserve rate cuts.

Traders kept a close eye on news regarding the U.S. presidential race, while remaining cautious ahead of Sunday’s elections in France.

JPMorgan Chase & Co.’s Marko Kolanovic says the S&P 500 will falter in coming months in the face of mounting headwinds, from a slowing economy to downward earnings revisions. The gauge is poised to plunge to 4,200 by year-end, a roughly 23% drop from Thursday’s close, he said.

“There is a clear disconnect in the huge run-up in U.S. equity valuations and the business cycle,” the strategist wrote, adding that the S&P 500’s 15% year-to-date gain isn’t justified, given waning growth projections.

The S&P 500 fluctuated after briefly topping 5,500 earlier Friday. Nvidia Corp. swung between gains and losses. Nike Inc. tumbled 20% on a disappointing outlook. Treasury 10-year yields rose six basis points to 4.35%.

S&P 500's Rally Wanes

Stocks are heading into the second half having gained about 15% this year. Historically, a strong first half tends to be followed by above-average second-half returns, according to Adam Turnquist at LPL Financial.

“While elevated valuations, overbought conditions, and underwhelming market breadth point to a potential pause ahead, seasonal trends suggest momentum could continue in the second half,” he noted.

The S&P 500 has followed up a positive first-half return with an average second-half gain of 6%, Turnquist added. Furthermore, when first-half gains were 10% or higher, the index posted average gains of 7.7% in the second half, with 83% of occurrences producing positive results.

Source: Ned Davis Research Source: Ned Davis Research

The U.S. presidential election and its aftermath promises investors big market swings in the second half of the year, says Goldman Sachs Group Inc.’s Scott Rubner.

The global markets division managing director and tactical specialist has been correctly bullish on US stocks in May and June, but after July 17 he is modeling a correction in the stock market — this usually means about a 10% drop for equities.

“I would be looking to trim exposure up here post July 4th,” Rubner wrote in a note to clients Friday.

Earlier in the session, traders kept a close eye on economic data.

U.S. consumer sentiment declined by less than initially estimated on expectations inflationary pressures will moderate. The Fed’s preferred measure of underlying U.S. inflation decelerated. Household spending rebounded and incomes showed solid growth, offering some hope that price pressures can be tamed without lasting damage to consumers.

“From the market’s perspective, today’s PCE report was near perfect,” said David Donabedian at CIBC Private Wealth U.S.. “The Fed’s favorite inflation indicator not only showed inflation was moving towards the Fed’s inflation target, but that the economy is resilient. Consumer spending was on the rise and take-home pay was also up after a couple of sluggish months.”

Softening in the measure of inflation favored by the Fed highlights a slowing economy that’s upping the risk of a policy error by the central bank, Mohamed El-Erian said.

“The economy is slowing faster than most economists expect and faster than what the Fed expected,” El-Erian, the president of Queens’ College, Cambridge and a Bloomberg Opinion columnist, told Bloomberg Television on Friday.

To Seema Shah at Principal Asset Management, while the inflation data is a relief and will be welcomed by the Fed, the policy path is not yet certain.

“A further deceleration in inflation, ideally coupled with additional evidence of labor market softening, will be necessary to pave the way for a first rate cut in September,” she noted.

Traders Diverge Further From Fed on Rate Cuts | Fed guidance for one cut defied after PCE data shows slowing inflation

Fed Bank of San Francisco President Mary Daly told CNBC said the latest inflation data indicates monetary policy is working, but said it’s too early to tell when it will be appropriate to lower borrowing costs.

Earlier Friday, her Richmond counterpart Thomas Barkin said the inflation battle still hasn’t been won, and the U.S. economy is likely to remain resilient as long as unemployment remains low and asset valuations high.

“The soft inflation data will build the case that the Fed can start cutting rates in the coming months,” said Jeffrey Roach at LPL Financial. “As long as incomes grow at a healthy clip, consumers will keep spending. The key is the labor market and so now, we should shift our attention to next week’s nonfarm payroll release for a fresh look into the job market.”

The timing of the first rate cut matters because bonds rally in anticipation of that cut, according to Joe Kalish at Ned Davis Research.

“Any second half bond market outlook is contingent on Fed policy,” he said. “The timing of the first rate cut has historically been important for the bond market, as yields tend to peak 2-3 months before the first rate cut.”

Credit: Adobe Stock

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