August Outlook: Hot Julys Often Bring Late-Summer/Autumn Buys
By: Jeffrey A. Hirsch & Christopher Mistal
July 26, 2018
Geopolitical concerns over the past few months from snafus and issues at the U.S. southern border over immigration disputes to tough tariff talk and trade war concerns have been shrugged off by the market since the end of June. Positive Q2 earnings, rising GDP growth, sustained unemployment and low rates continue to please the market, sending the market higher in July. This put DJIA up 4.00%, S&P 500 up 3.75% and NASDAQ up 4.40% for the month of July so far, qualifying this as a “Hot July Market”. 
Gains of this magnitude for July, however, have frequently been followed by a late-summer or autumn selloffs and better buying opportunities than now. In the past, full-month July gains in excess of 3.5% for DJIA have been followed historically by declines of 6.8% on average in the Dow with a low at some point in the last 5 months of the year.
[Hot Julys Table]
Our concern presently is that as the market enters the historically worst two months of the year, August and September, it is getting a bit extended. This is reminiscent of the market in January 2018. Equity prices are once again pushing the top of the trading range and sentiment is heating up again. Sentiment is not quite as high as it was in January, but the market is more vulnerable seasonally as August is historically the worst month of the year. Volume tends to dry up during the vacation month leaving a vacuum of buyers that has frequently sucked the market lower.
In the chart below of the S&P 500 Seasonal Patterns, you can clearly see the S&P 500 in 2018 as represented by the black line finally poking above recent overhead resistance at the March and June highs. However, it is now at the time of the year historically where the market has stalled at its seasonal peak. The green line representing all years since 1949 and the blue line representing the years since the 1987 Crash both enter a sideways to lower trajectory from August through October.
The red line that represents the average of all midterm years since 1949 is clearly weaker during the historically worst six months May-October. This year has defied history for now, but the concern is that the market is poised to revert to the mean and consolidate over the next three months, more in line with the midterm year seasonal pattern.
However, we are not expecting any major selloff or decline at this juncture. We searched high and low and negative indicators and data are few and far between. The biggest risk to the market right now is the Fed. So far this new Fed under the guidance of Chairman Powell seems to be doing a superlative job. But that job entails normalizing rates as much as possible and reducing the balance sheet to chaperon the economy and market into a healthy growth state without the Kool-Aid of super easy money.
For now, expect the market to fade into summer with increased volatility heading into what promises to be a rather contentious midterm election season with a low point in the August-October time frame, holding the February/March lows at worst. Then as we hit the sweet spot of the 4-Year Cycle, which begins in Q4 of the midterm year (as you can see in the chart) and runs through Q2 of the pre-election year we expect the market to rally to new highs toward yearend 2018 and into 2019.
Pulse of the Market
Late-June’s market swoon ended just days before the third quarter began. Q3 began in typical fashion with gains on the first trading day of July and NASDAQ’s Mid-Year rally gained traction lifting the overall market higher. DJIA quickly reclaimed its 200- and 50-day moving averages (1) and is currently trading at its highest levels since late February. The shift in momentum was confirmed by both the faster and slower moving MACD indicators applied to DJIA (2). Both indicators remain positive and trending higher.
At the start of this week DJIA logged its sixth Down Friday/Down Monday (DF/DM) of 2018 (3). Declines on Friday and Monday were mild and were recovered quickly. Historically when this has occurred subsequent declines were mild or avoided all together. Provided data and headlines remain favorable, this is likely to be the outcome in the near-term.
Recent technology strength has lifted S&P 500 (4) in seven of the last nine weeks while NASDAQ (5) has advanced in six of the last nine weeks. DJIA has been slightly weaker, up five of the last eight weeks. This lagging performance by DJIA appears to be fading this week, but DJIA is still furthest from its all-time closing high last reached in January.
Market breath has been mixed with NYSE Weekly Advancers out numbering NYSE Weekly Decliners in two of the last four weeks (6). Last week’s slightly positive breadth was accompanied by a minor NASDAQ loss and two weeks ago all three indexes advanced solidly, but breadth was negative. New Highs and New Lows (7) continue to oscillate with no clear trend for any meaningful duration of time. Expanding numbers of New Highs and shrinking number of New Lows is usually the trend of a healthy bull market.
30-year Treasury bond yields (8) have slipped below 3% suggesting long-term growth and inflation are likely in check. The 90-day Treasury yield has resumed its march towards 2% after pausing around 1.9% for seven weeks. The flattening of the yield might be a signal the Fed should heed.
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[Pulse of the Market Table]