It’s been a remarkable seven months. Going into August, you can’t help but be impressed by the momentum. Consider: The S & P 500 hasn’t seen a 1% down day in two months . The last one was May 23, when it was down 1.1%. The S & P 500 is going to close higher for five consecutive months. That is only the 30th time that has happened since 1949, according to Sentmentrader.com. It’s only had two down months out of the last 10. The market really is broadening out . While the first part of the year was dominated by the AI Revolution and a small group of tech stocks , all 11 sectors in the S & P 500 are up in July. The S & P 500 advance/decline line, which measures the daily activity of how many stocks are advancing versus declining, has been rising steadily for the past two months. What’s caused this amazing run, and what will the rest of the year look like? What’s driven stocks in the first seven months The “soft landing” is built on three concepts: lower inflation, slower but still strong job growth, and a stabilization in rates. Lower inflation . Headline PCE (personal consumption expenditures prices), the Fed’s preferred inflation measure , has gone on a 12-month basis from 7% in June of last year to 3% in July; core PCE (ex-food and energy) has gone from 5.4% in February 2022 to 4.1% in July. Job strengt h. Nonfarm payrolls are lower than this time last year but still strong; the unemployment rate has remained in the 3.5% range for the past year. Stabilization in rates . Ten-year yields have remained between 3.4% and 4% all year; the few times they have strayed above 4% (March, early July, and July 27), the market has moved lower. The triumph (so far) of the soft landing has enabled earnings estimates to stabilize. Earnings stabilize . The trend has gone from “lower” in the first part of the year to “stable” in the last few months. Bulls are hopeful the second quarter is the trough and earnings will start moving higher from here. P/E expansion . Earnings may have stabilized but they need to start growing. Forward earnings estimates for the S & P 500 started the year at 17 (about an average multiple) and are now at 19.9, a very rich multiple implying investors are anticipating earnings will be materially higher in the future. Naturally, there are plenty who think the rally won’t last Since so many have capitulated to the soft landing side, the arguments against the market rallying any further are largely technical and seasonal: Valuations are too high . This is partly true: Prices have risen but earnings have not, though not in every sector. Some sectors have seen very little multiple expansion. This is a seasonally weak period of the year . Also true: August is the third worst month, September is the worst month historically. Momentum this strong cannot last . Also true, but not interesting. In truly powerful up markets, stocks can stay higher for a lot longer than cynics want to believe. “Big uptrends don’t turn on a dime,” Frank Gretz at Wellington Shields said in a recent note to clients. “Tops occur when markets lose participation as the money runs out — little sign of that so far,” Gretz said. Still, after a 19% gain in seven months, and with the S & P less than 5% from its January 2022 historic high, most investors are rightly questioning how much more upside the market can pull off. “I think the easy money has been made, and the pace of gains will be more modest for the rest of the year,” Alec Young at Tactical Alpha told me. “This is like having a big lead at the end of the third quarter,” Young said. “You don’t want to give up the lead.” What will it take for stocks not to “give up the lead?” What will be the drivers of stocks for the rest of the year The market will need to deliver on the two primary movers of the first half: the soft landing story and a U-shaped recovery in earnings. Earnings ramp-up . “Earnings growth has to drive the next leg of the bull,” Young said. “Consensus is for earnings to be up double digits next year. We need to see that come through.” He’s right: the P/E expansion has its limits. More than any other issue, earnings have got to start improving. They already are: the second quarter is expected to be the “trough” for this earnings cycle. Estimate for the rest of 2023 and into 2024 are all notably higher, and double-digit growth is indeed expected by the second quarter of next year. S & P 500 (dollar estimates) Q1: $53.08 Q2: $52.25 Q3: $55.46 Q4: $57.37 Q1 24: $57.36 Q2 24: $59.72 Source: Refinitiv One sign earnings may indeed be rising: In the past two weeks, the vast majority of earnings revisions have come from analysts revising estimates upward. Some 61% of earnings revisions have been higher, while only 31% are lower, according to Refinitiv. The soft landing data must continue . Fed Chair Jerome Powell’s remarkable admission last week that the Fed staff was no longer modelling a recession and that inflation had a shot at returning to its 2% target without high unemployment pushed even more investors into the soft- landing camp. Most of the data continues to point toward lower inflation , yet interest rates remain stubbornly high, and that could prove to be a serious stumbling block for a market advance. “If shallow is all we get, then the market cycle seems to be justified in claiming victory, even if the Fed is not yet willing to do its part,” Jurrien Timmer, director of global macro at Fidelity Investments, said in a recent note to clients. “The market can and will look past an earnings valley, but it usually gets help from the Fed to get to the other side.” High rates by themselves may provide a perfectly good excuse for the market to pause in August, particularly if next week’s jobs report comes in higher than expected. “Investors need to be careful about trying to squeeze every last penny out of this rally given that the market is expensive and interest rates are very near multi-year highs,” Matt Maley, chief market strategist at Miller Tabak, told me.
