Signs of weakness lurk beneath the stock market’s surface. But here's why you shouldn't worry.
Stock market veterans love to say “the trend is your friend, until it ends.” And some investors worry that may come true soon even with Wall Street at record highs.
A shift has taken place beneath the stock market's surface in recent months, and that means the all-time highs in stocks might be in jeopardy, analysts say.
Wall Street watchers point to this concern: Fewer stocks are part of the market rally, which is often viewed as a warning sign for investors.
What does that look like? Take, for example, that the percentage of NYSE common stocks trading above their 30-day moving averages dropped to 45% on July 2, down from 83% on May 7, according to Lowry Research, a technical advisory service.
That would suggest choppiness for stocks in the coming months, analysts say.
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So does that mean for trouble for your nest egg?
Not necessarily. So don’t freak out just yet.
If anything, the stock market has remained resilient despite concerns about the economic effects of the spread of the Delta coronavirus variant and worries about how the Federal Reserve will react to rising inflation, analysts say.
So far, the S&P 500 has rallied 90% from the depths of its pandemic lows. Any weakness could present an opportunity to scoop up more stocks at lower prices, or you could at least hold steady in your retirement accounts, money managers say.
Even if the trend stops being your friend, don't become your own worst enemy by letting emotion dictate your investments.
I remember when stocks fell sharply in October 2018 on worries about the state of the global expansion. Trading was choppy the next few months and then stocks plunged that December, pushing the S&P 500 on the brink of a bear market with a decline of nearly 20% from its peak.
Some investors panicked, but markets quickly revived in the following weeks and staged a dramatic turnaround after the bruising sell-off. One analyst I spoke with at the time said that correction had been building for months but ended up being short-lived. When their emotions ran high, I had friends who cashed out of a few stocks they owned. But they soon regretted it once stocks regained their footing.
There may be bumps along the way, but sit tight
Now's when a cool head will help you think counterintuitively.
“You want to be the most greedy and hungry to buy stocks when prices are down rather than when prices are up,” says Sam Stovall, chief investment strategist at investment research firm CFRA. “You’re better off buying than bailing.”
For long-term retirement savers, history suggests that you’re better off holding steady, Stovall added.
That’s true for Courtney John, 33, a community recreation director for the city of Saint Paul, Minn.
She and her husband Spencer, a chiropractor, aren’t worried about what twists and turns the market could bring this year. They’re investing for the long haul and they poured their stimulus checks into their Roth IRAs over the past year. They both have an employer-based retirement plan that they contribute to as well.
Although they’re chipping away at student loan debt, they both benefited from a reprieve in federal student loan payments during the pandemic and were able to score a low mortgage rate last fall for their dream home.
So for now, they're not paying attention to the daily stock market swings.
“We’re only in our thirties. We have decades to ride the ship,” says John, who continues to make automatic contributions to her retirement accounts. “If something were to happen, we have a lot of time to make it up.”
Where the market stands
The S&P 500, the benchmark used for most mutual funds, recently posted ten record closing highs in the span of 12 trading days, which is typically uncommon over the past half century, according to Bespoke Investment Group.
This could bode well for Wall Street later this year. After stocks hit new highs in bunches like this, median returns over the following six and twelve months were 5.5% and 14.4%, respectively, Bespoke data shows.
Market watchers, however, point to a broader issue: Fewer stocks are hitting new highs.
So why should you care? In general, market breadth, or how many stocks are participating in the rally, remains strong over the long term.
How do we know? Something called the 200-day moving average calculates the average price of stocks over that stretch. More than 90% of stocks in the S&P 500 currently trade above their 200-day moving average. It's a less bumpy number and it steps back and signals how things look from higher up.
Shorter-term measures, however, tell a different story though and suggest weakness in the coming months.
For instance, only 31% of the 147 sub-industries in the S&P 1500, which covers more than 90% of the total market capitalization in the U.S. stock market, traded above their 50-day average through Thursday, down from 90% on May 7, data from Lowry Research shows.
Fewer new highs among stocks are like a canary in a coalmine: They're a signal of how market conditions may change. This implies that a decline in the stock market may be approaching, analysts say.
So when will a bigger pullback come?
Through Tuesday, it’s been 293 calendar days since the S&P 500 has gone without a drop of 5% or more, according to CFRA. That bucks a historical trend. Since World War II, the average is 178 calendar days.
The stock market typically sees about three 5%-plus falls a year on average. That makes the market more vulnerable in the near term following some signs of investor complacency, analysts say.
No one knows for sure when the next significant decline will be, but so-called market "technicians" monitor these clues to gauge when the trend may start to change.
The lack of breadth in the stock market is concerning to some analysts in the near term. If only a handful of sectors are driving the market’s advance, then analysts become more skeptical about the trajectory of the market.
If you have a carriage that is pulled by 20 horses, it has a greater likelihood of going faster and farther than one that’s being pulled with just two horses, Stovall explained.
The financial, industrial and materials sectors, which were standouts earlier this year, have struggled of late while technology, a winner in the stay-at-home economy, has gained ground after faltering in recent months after investors shifted away from growth stocks and opted instead for value companies.
Big Tech makes up an outsize portion of the S&P 500, and the performance of the biggest stocks can have a disproportionate effect on the index. But technology leading the way isn't necessarily a bad thing over the long haul, according to Willie Delwiche, investment strategist at market research firm All Star Charts.
"It's not a problem when tech leads the broader market higher," says Delwiche. "It's a problem if the rest of the stock market doesn't follow."
Right now, defensive corners of the stock market—such as utilities and consumer staples—aren't leading the charge. Those types of so-called safety stocks have steady dividend payouts, which become more attractive in times of economic uncertainty.
If they were currently pushing the market higher, that would typically be a red flag, Delwiche added.
Stocks poised to benefit as economy recovers
To be sure, a bear market, or a drop of at least 20% from record highs, isn’t likely anytime soon, analysts say.
The stock market is likely set to keep climbing in the second half of 2021 and beyond as the economy recovers from the pandemic. Propelling that expansion are a strong housing market, robust consumer spending, better-than-expected corporate profits, a healing jobs market and unprecedented policy support from Washington and the Federal Reserve.
At this point, any bumps along the way aren't surprising to analysts as the market reacts to tensions between better economic and corporate earnings growth and the worries about higher taxes and rising interest rates, analysts say.
Although the Fed signaled that higher inflation is likely to be temporary, concerns have grown among investors that the central bank may move to raise borrowing costs sooner than planned, which may add to market volatility. The consumer-price index for June showed inflation rising at its fastest pace in more than a decade.
The second year of a bull market also tends to be choppier, with positive but moderating returns and periodic pullbacks. Going back to 1957, the average return in the first year of a bull market is 43.3%, compared with 13.3% in the second year, according to Truist Wealth.
Looking ahead, technicians are monitoring the NYSE advance-decline line, an indicator that tracks the number of stocks rising minus the number falling each day. It has signaled recently that fewer stocks are making new highs.
But there’s a silver lining: Fewer stocks recorded new lows coming into last week. And that’s a positive sign because trouble begins when there are more new lows than new highs, according to Delwiche.
“We’re seeing an absence of strength, not a sustained emergence of weakness,” says Delwiche. “The number of stocks hitting new lows isn’t growing, which is a sign that the market could get back into gear.”
What should you do?
As George Constanza once said: Do the opposite. So if stocks are falling, increase your exposure to them, Stovall says.
For long-term retirement holders, history suggests that you’re better off sitting tight, he added.
“There are times when you may want to aggressively buy stocks and other times when you may want to sell stocks. Then there are times when you do nothing and go fishing," says Delwiche. "This is that third time."
And Courtney Johns is taking that to heart.
“I’m very Type A and neurotic. So I’m learning now in my thirties that I can’t control everything," she says. "For me, not paying that much attention to what the stock market is doing is self-care. I already have so many other things to obsess over.”