There are reasons to be optimistic as stock market faces a tough adversary.
August and September have had dismal records for stock returns over the past 20 years and with strategists warning that the market is overdue for a major correction, the next two months could be rough. But there are reasons to believe that any impending selloff may not be as cataclysmic as some fear.
Bank of America Merrill Lynch’s technical research analyst Stephen Suttmeier pointed out that there are some very important factors that suggest that the market’s upward trajectory remains very much intact despite the track record working against it.
“First half 2017 was above average and this bodes well for second half 2017 and the data for all periods, secular bull market years, and Presidential Cycle Year 1 suggest that the S&P 500 could end the year in the 2,550-2,640 range,” said Suttmeier in a report.
In fact, during the early part of the presidential cycle, if stocks perform better than average in the first six months, the index rises 75% of the time in the second half with an average return of 5.38%, he said.
The S&P 500 rose 8.2% from January to June and finished July 1.9% higher.
Subdued volatility in the market is another reason to be optimistic. Suttmeier notes that the CBOE Volatility Index VIX, -3.93% Wall Street’s so-called fear index, is trading at record lows.
“The CBOE Volatility Index remains low and near 10 after hitting a record intra-day low of 8.84 on July 26. Data back to 1990 suggest that VIX is typically closer [to] 20 plus when the S&P 500 starts a correction of 5%, 10%, or 20%,” the analyst said.
Things are looking fairly solid from a technical perspective as well. The NYSE advance/decline line — which tracks the number of advancing stocks minus the declining shares each day and adds that to the figure from the previous session — is at fresh highs, pointing to a limited downside even if the market turns south.
But the best case for the S&P 500’s uptrend may be the following chart in which Suttmeier illustrates how the current bull market is tracing a similar path as the rallies of 1980 and 1950.
“We believe that 2017 is the year of acceptance for the secular bull trend that began on the April 2013 upside breakout. The prior bull market breakouts from 1950 and 1980 lasted 15-20 years, which suggests that current secular bull market may have a decade or more to run,” he said.
A soft U.S. dollar is also a boon for the market as a weak currency makes exports more price-competitive.
Emmanuel Cau, an equity research analyst at J.P. Morgan Cazenove, expects foreign exchange to further bolster earnings in the second half, citing the euro’s strength against the dollar for the outperformance in U.S. sales versus Europe.
The euro EURUSD, -0.8088% has rallied 18% against the dollar this year, according to FactSet.
David Kostin, chief U.S. strategist at Goldman Sachs, likewise believes the dollar’s steep drop helped to boost S&P 500 companies’ results given that one-third of their revenues are generated overseas. Kostin estimates that each 10% decline in the U.S. dollar has the impact of adding roughly $3 to S&P 500’s earnings per share.
The greenback, as measured by the U.S. Dollar Index DXY, +0.75% is down 8.5% since the beginning of the year.
Meanwhile, corporate earnings continue to be supportive of stocks. As of Friday, with 84% of S&P 500 companies having released second-quarter results, 72% have reported better than expected earnings and 70% have beat sales estimates, according to FactSet.
“For now, the path of least resistance is still higher for stocks, especially since forward earnings continue to blaze that trail,” said Ed Yardeni, chief investment strategist at Yardeni Research, in a note to investors.
“As strategists, we are aiming for 2,700 by the middle of next year, a four-fold increase since March 2009. Assuming a forward price-to-earnings of 18, we would need to see forward earnings climb to $150 per share by the middle of next year, up about 7.4% from the latest reading in late July. That’s realistic, in our estimation.”
The Dow Jones Industrial Average DJIA, +0.30% closed at a record on Friday after easily breaching 22,000 during the week while the S&P 500 SPX, +0.19% also closed in positive territory. The tech-laden Nasdaq COMP, +0.18% however, fell for a second week in a row.