An important lesson in market history: Keep calm and carry on

It’s just a market cycle EDITOR’S NOTE: I’m sharing some market analysis from the team over at Avalon today. From time to time, I like to give you a behind-the-scenes look at what clients at money management firms come to expect from their investing teams. Everybody needs to settle down! YES, the stock market is messy – and it’s not trending higher at the moment. I’m sure for many investors that’s both frustrating and scary. But it’s not so scary or unexpected if you have taken the time to study your market history. Yeah, I know. What a snooze fest! But well worth a few minutes of your time. So for all of you who missed that day in school - I bring you: Market History 101. Don’t worry, this will be short, painless, and productive. Markets have seasons. Some seasons are sunny and warm – and others, well not so much. Sometimes the season is gloomy and cold. This year is no different. The market is following a very typical seasonal pattern, where the stock market struggles in the months of August and September – with September being the worst-performing month of the calendar year for stocks. So the market is doing exactly what it often does this time of year. And when we dig a little deeper into our market history and look back at 4-year Presidential cycles, you’ll notice that the stock market is also following its typical cycle behavior. You can see it for yourself in the chart below. I’ve highlighted the Pre-Election year (2023) of the 4-year Presidential cycle. The black line represents the historical 4-year cycle for stocks. The red line is 2023 specifically. This year, the S&P 500 followed the historic trend by moving higher between January and July – its most recent peak, followed by August and into September with sideways consolidation. Seasonality isn’t foolproof – sometimes markets ignore seasonal trends. But it’s too early to say this time is different. It’s best to remember our history. And as the saying goes, “History may not repeat itself, but it often rhymes.” It’s worth noting that with all that history going back to the 1950’s and in all those decades since, we’ve had Democrats in office, we’ve had Republicans in office, we’ve had high inflation and low inflation, we’ve had changes in monetary policy, higher rates, lower rates, etc, etc. The fact is markets have seasonal and cyclical tendencies. By understanding them you’ll not only be better prepared to manage the risks and opportunities that arise during these cycles, but you’ll have an easier time managing your emotions. That does not imply investors should trade solely based on seasonality patterns. These patterns are just another data point you should be aware of as we build a weight of the evidence market thesis. With that said, we’ll use this information as our backdrop, as we analyze some recent price action. In an ADAPT article last week, I suggested that the area to watch on the S&P 500 was the range between – let’s call it 4300 and 4600. I stated that the S&P was range bound, as it continued to find resistance around 4600 and importantly support right around 4300. I’m of the opinion that IF, that 4300 area holds, then we may be setting up for a rally into the year-end. However, If 4300 doesn’t hold – then this may be the start of something more severe. Remember folks, big problems often start as small problems. So the price chart of the S&P is one you’ll want to keep an eye on (4300~4600). Since my original article, the S&P 500 did break below support for a hot second (around 4250) as seen in the chart below. But rather than continuing lower, the S&P has since shown some strength by moving back above our area of support (4300). That would suggest buyers are willing to defend this level, at least temporarily – check one for the bulls. However, we can’t ignore the lack of participation we’re seeing from stocks of the S&P. There are a few important measures of breadth that still need to improve before we can more comfortably say that markets are setting up for a year-end rally. Conventional wisdom says that in a bull market, we should expect to see at least 50% of the stocks trading in the index above their own 50 and 200-day moving averages. Annnnd they’re not. Until they do we need to remain cautious. I have to admit, It’s hard to be overly bullish while so few stocks are trading above their 200-day and 50-day moving averages. Currently, only 41% of stocks are above their 200-day moving average and only 20% of stocks are trading above their shorter 50-day moving average. We remain well below the baseline that is considered a hallmark of a healthy market. In addition, we’re seeing lower highs and lower lows of the Advance/Decline line for the NYSE, Large-caps, Mid-caps, and Small-caps. Until that statement is no longer true, we’ll reserve our bullish thesis for stocks going into year-end. So those are just some of the technicals we’re watching for at the index level. From a sector perspective, it’s usually technology that gets all the attention – and for good reason as it makes up for more than 30% of the index. However, I’m keeping a keen eye on Financials (XLF). This is arguably one of the most important sectors in our markets. And a sector I watch as an indicator of a healthy economy here in the U.S. Financials don’t have to be the strongest sector – but they can’t be the weakest either. And that’s what I’m watching for. Financials have to show up – or in this case, at least hold on. So far they’ve been able to do that. XLF WEEKLY As long as Financials can remain above the line in the sand at the 2008 and 2018 highs, then this probably remains a case of messy for longer for stocks in general. However, if Financials break below support – as they did in 2008 and 2018, history has shown it’s not a good sign for equity markets or the U.S. economy. In close, the message is this – we remain in the seasonally weak part of the calendar year for stocks. They're doing exactly what we would expect them to do so let's not hit the panic button just yet. But other questions remain… Will Fed policy ultimately be too much for the markets to overcome or is this just going to be messy for longer? Will breadth improve, indicating more and more stocks are ready to participate to the upside – adding to the bull case for stocks into year-end? Stay tuned as we watch for more clues. 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