S&P 500 Braces for Seasonal Headwinds: Can the Record Rally Continue?

S&P 500 Braces for Seasonal Headwinds

Having enjoyed its best winning streak since 2020, the S&P 500 is preparing to navigate a historically tricky period during August and September. Historical data suggests these months are typically the worst performing for the benchmark index, averaging a 0.7% decline each, compared to an average gain of 1.1% for other months. Analysts partially attribute this seasonal pattern to fund managers tending to re-evaluate their portfolios around this time of year.

Seasonal Risks and Other Challenges

This seasonal risk amplifies a growing feeling on Wall Street that the record-breaking stock market rally might need a breather, especially with valuations appearing stretched and key events on the horizon. Investors are keenly awaiting the Federal Reserve's decision, watching to see if Chairman Jerome Powell will lay the groundwork for interest rate cuts later this year, or signal that more time is needed to assess the impact of tariffs on the economy. "If Powell hints that rate cuts are not on the cards in the foreseeable future, traders will be disappointed, which could trigger a short-term selloff," said Ed Clissold, chief U.S. strategist at Ned Davis Research. "Any bad news could cause a stock market correction."

Prior Strong Performance and Potential Reactions

The S&P 500 has already staged a remarkable rally, surging 28% in the past 75 trading days. According to data compiled by JPMorgan Asset Management, this is the biggest gain over such a sustained period since the stock market recovered from the brutal sell-off at the start of the COVID-19 pandemic. The temporary pause of some tariffs by former U.S. President Donald Trump has contributed to attracting investors back into the market. However, any shift in tariff news, economic data, or corporate earnings could trigger stock market sell-offs during August and September.

Portfolio Re-evaluation and Defensive Posturing

This timeframe marks a period when investors return from summer holidays, tending to re-evaluate their portfolios and adopt defensive postures. Companies also prepare for next year's budgets and consider tightening spending. In addition, mutual funds sell losing positions to reduce the size of their capital gains distributions.

Looking at the Past and Future

It's important to recognize that past performance is no guarantee of future returns. Data indicates that August has registered positive returns in 5 out of the past 10 years. Although traders' exposure to stocks is increasing, it's still only "moderately overweight."

Uncertain Future

Despite potential risks, there's some optimism. Some suggest that any dip could be short-lived and limited. Jeffrey Hirsch, editor of the Stock Trader's Almanac, believes this rally still has room to grind higher, albeit at a more moderate pace. However, data suggests that Commodity Trading Advisors (CTAs), who typically buy stocks when prices rise and sell when they fall, currently hold large long positions in stocks, the highest since January 2020. While this signals confidence in the stock market, it also increases the risk of a sharp reversal should market conditions change.

Monitoring Key Indicators

Mark Newton, head of technical strategy at Fundstrat Global Advisors, warns that seasonal patterns suggest the stock market may peak in mid-August. He added that any spike in bond yields, which could lead to higher borrowing costs for companies, would also degrade the outlook. Newton says: "The warning signs I’m watching for are whether yields spike higher, whether positioning turns more defensive, and whether market breadth weakens, but none of those things have happened yet." **Important:** This analysis is for informational purposes only and does not constitute investment advice. Investors should conduct their own research or consult with a financial advisor before making any investment decisions.