The U.S. stock market closed out a turbulent July, characterized by election uncertainties, fluctuating interest rates, and lackluster earnings that sent megacap technology stocks on a volatile ride. As August approaches, historical trends and current market dynamics suggest a potential rally, but caution is warranted due to an ongoing market rotation.
Historically, August has been a favorable month for the stock market during presidential election years. Data shows an average monthly return of 3.2% for the Nasdaq Composite, making it the best month for the tech-heavy index since 1971. Similarly, the S&P 500 has posted an average gain of 1.3% in August, marking it as the fifth-best month for the large-cap benchmark since 1950. The Russell 2000, representing small-cap stocks, has seen an average return of 3.5%, its second-best month since 1979.
Jeffrey Hirsch, editor of the Stock Trader’s Almanac and Almanac Investor Newsletter, notes that election years tend to be bullish, with above-average performance typically seen in June, July, and August. However, he cautions that 2024 has already seen significant gains, suggesting some of the historical August performance may have been pulled forward.
So far in 2024, the S&P 500 and the Nasdaq have risen 16% and 17%, respectively, according to FactSet data. However, the rally took a pause in July as Wall Street’s “Great Rotation” gained momentum. This shift from Big Tech to other market sectors was exacerbated by disappointing earnings from Tesla Inc. (TSLA) and Alphabet Inc. (GOOG, GOOGL), leading to a sharp sell-off in tech stocks.
Unique Summer Dynamics
What sets this summer apart is the election year context. Over the past 36 years, August has typically been a challenging month for the Dow Jones Industrial Average (DJIA) and the S&P 500, with both indices often underperforming. Hirsch attributes this shift in August performance during election years to the clarity that comes once top candidates are confirmed.
Despite the historical trends, the third quarter is often volatile for the stock market. Henry Allen, a macro strategist at Deutsche Bank Research, highlights that the average spike in the VIX index, Wall Street’s “fear gauge,” is higher in the third quarter than any other. The Cboe Volatility Index (VIX) surged over 30% in July, marking its largest monthly increase in more than two years.
Colin Graham, head of multi-asset strategies at Robeco, interprets the July volatility as a market correction, noting that a VIX level between 18 and 20 is more typical compared to the lower levels seen earlier in the month. He suggests that the market’s “elastic band” had become too stretched, leading to a snapback.
Future of the ‘Great Rotation’
Many investors anticipate the rotation from Big Tech to small-cap stocks and other sectors will continue, although some are cautious about its sustainability. Graham points to sluggish manufacturing sectors globally, particularly in China and Germany, as a potential hindrance to the broadening of the market.
China’s manufacturing activity contracted for the third consecutive month in July, while U.S. manufacturing also showed weakness, continuing a three-month decline. This industrial slump casts doubt on the viability of shifting investments from growth-oriented tech stocks to more cyclical sectors.
Tony Roth, chief investment officer at Wilmington Trust, advises investors to brace for additional market volatility, particularly with several Big Tech companies set to report quarterly earnings in early August. Apple Inc. (AAPL), Amazon.com Inc. (AMZN), and Nvidia Corp. (NVDA) are among the key players whose performance could significantly impact market sentiment.
Roth underscores the high expectations for tech company earnings, warning that there is little room for error given the elevated stock valuations. The recent rebound in tech stocks, driven by positive earnings updates from Microsoft Corp. (MSFT) and Advanced Micro Devices Inc. (AMD), demonstrates the market’s sensitivity to Big Tech performance.
Conclusion
As August unfolds, investors should remain vigilant, balancing historical trends with the current market rotation and economic signals. While election-year dynamics have historically bolstered the market, the unique circumstances of 2024, marked by sector rotations and macroeconomic uncertainties, call for a cautious approach. Monitoring earnings reports and economic indicators will be crucial for navigating the potential opportunities and risks in the coming months.
