David Randall
NEW YORK (Reuters) – U.S. stocks may see a more pronounced summer slump this year as inflation worries and early presidential debates could weigh on the rally that has driven the S&P 500 to near record highs in recent months.
The S&P 500 has risen nearly 12% this year on strong earnings and signs that inflation may be falling enough for the Federal Reserve to cut interest rates, but investors say that rally is unlikely to last in coming months.
Summer has historically been the weakest season for U.S. stocks. The benchmark S&P 500 rose 56% from June to August, according to CFRA Research data stretching back to 1945. Traders on vacation and investors waiting for fall earnings reports before deciding next year's asset allocations are often cited as reasons for the summer slump.
But further headwinds are likely this summer, with continued uncertainty over the timing of rate cuts and the uncertainty of the US presidential election likely to make for volatility.
“The market is pretty expensive at this point and everything would need to go right between now and July for the Fed to cut rates,” said Samir Samana, senior global market strategist at Wells Fargo Investment Institute.
“There's not much in sight to spark a further upswing, so the usual seasonal slowdown is likely to accelerate this year.”
Inflation data will be a key market driver for the rest of the year determining the direction of Treasury yields and the relative attractiveness of government bonds compared to stocks.
The S&P 500 is currently trading at 21.6 times forward earnings, compared with roughly 17.5 times in October, when the 10-year Treasury yield hit a 20-year high.
Better-than-expected inflation data earlier this year receded expectations of a Fed rate cut in 2024 and sent yields rising across the board. A slowdown in price growth in April was then widely taken to give the Fed more room to ease, and markets are now pricing in a 35 basis point rate cut by the end of December.
But another strong reading in June or July could dash those hopes. The next personal consumption expenditures report is due Friday, and the consumer price index report is due June 12.
“The real challenge is on the relative side: if yields spike and the Fed doesn't cut rates, investors will move into bonds and cash,” said Ed Clissold, chief U.S. strategist at Ned Davis Research.
At the same time, global fund managers are allocating to equities at their highest level since January 2022, according to Bank of America Global Research.“When everybody’s long, there’s no one to buy,” said Giuseppe Sette, president of market research firm Toggle.
Close race
Another unknown in this year's presidential election is what will happen between Democrat Joe Biden and Republican former President Donald Trump.
Sam Stovall, chief investment strategist at CFRA Research, said the S&P 500 has a 75% chance of rising between Memorial Day and Labor Day when a first-term president is running for reelection, but this year's election has been extremely close, with Biden nearly neck and neck with Trump in national polls.
The two also agreed to debate on June 27, which would be the earliest ever for a presidential general election debate and bring investor attention to the election outcome and policy implications much earlier than usual.
“The election is going to be pretty close so it's entirely possible we'll see some sort of sell-off in stocks as investors take a wait-and-see approach,” Clissold said.
(Reporting by David Randall; Editing by Michelle Price and Jonathan Oatis)
