August Stock-Market Fluctuations: A Potential Rout in the Making?

The recent decline in the 2023 U.S. stock-market rally during August was not unexpected.

Tom Lee from Fundstrat mentioned in a note on Friday morning that the recent 15-day decline of 5.6% in the S&P 500 is typical for August. Despite this, Lee, known for being optimistic about the stock market, believes that this decline is likely to be a temporary occurrence associated with the month of August.

August is typically a challenging month, characterized by high levels of volatility, as indicated by the peak in the VIX. Additionally, trading conditions often experience low volume, especially in the latter part of the month, as the vacation season comes to a close. According to the speaker, stocks are being sold off due to various understandable and reasonable factors. These factors include a 50 basis point increase in the 10-year Treasury yield, resulting in a 15-year high, the strengthening of the U.S. dollar, and a long-awaited surge in the Cboe Volatility Index.

On Friday, the S&P 500 index and Nasdaq Composite both experienced their third consecutive week of losses, while the Dow Jones Industrial Average endured a weekly decline of 2.2%.

What would be necessary for the slide to become a significant decline, as defined by Lee as a 10% drop to the 4,150 level for the S&P 500?

According to Lee, for the increase in yields to have a significant impact, it would have to pose a threat of causing significant damage or there would need to be some additional external disturbance.

“I am not suggesting that this is impossible. For example, if there is a sudden increase of 10% in oil prices and indications of rising wages, this could potentially lead to a bigger decrease in market value. The reason being, it would lead investors to doubt if inflation is consistently decreasing,” Lee stated.

According to Lee, currently, inflation is not the main concern as investors are more focused on the increasing bond yields, which negatively affect price-to-earnings ratios. They are also concerned about a stronger U.S. economy, which raises the possibility of more interest rate increases by the Federal Reserve. Additionally, Lee mentioned that weak economic data and property issues in China are also slightly concerning for U.S. investors.

However, Lee stated that there are indications in the market that stability could make a comeback in the near future.

To start with, he mentioned that the rise in the 10-year yield’s pace is negatively impacting stocks; however, it is not uncommon for such sudden increases to happen towards the end of a selling period for equities. He pointed out that the recent 50 basis point increase in the Treasury 10-year yield, which occurred within a span of 21 days, is similar to the yield increases observed on September 23rd and March 2nd in the previous year. It should be noted that during those instances, stocks reached their lowest point 8 to 16 days later.

Next, there is an overabundance of stocks as indicated by the McClellan Oscillator, which has declined to -50. This has only occurred 39 times since 1990. According to Lee, in 51% of these instances, stocks reached their lowest point within five days, and in 72% of cases, stocks hit their lowest point within 15 days.

Lee suggested a few dates that could be significant for the market’s future, one of them being August 24th, right after Nvidia, a chip maker company, announces its second-quarter financial performance. Nvidia’s exceptional results earlier this year were believed to have initiated a craze around artificial intelligence, leading to a surge in the stocks of large-cap technology companies.

Investors will also be taking notice on Friday, August 25th, as Federal Reserve Chair Jerome Powell is set to speak at the Kansas City Fed’s yearly symposium in Jackson Hole, Wyoming.

Lee recalled that Powell’s Jackson Hole speech last year signaled the end of a rebound for the S&P 500, leading to a subsequent decrease of 19% in stock prices over the following eight weeks.

“He expressed doubt that stocks could experience a 20% surge following this year’s Jackson Hole conference, however, he acknowledged that unexpected events might still occur.”

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