If you’re looking at the stock market’s rally to record highs in August, you might be wondering whether it’s time to pile in or pull back.
Answering the question “is now a good time to invest” has been particularly difficult this year given the volatility caused by the Iran war, periodic rotations in the AI trade, and fears of hotter inflation forcing rate hikes.
Major indexes have jumped in August, hitting record highs in the last week on tame inflation and upbeat earnings. The S&P 500 broke through the 7,800 ceiling for the first-ever time on Thursday, and the Dow Jones Industrial Average remains within striking distance of its own all-time high.
Yet, forecasters are also eyeing headwinds that threaten to spoil the party. A resolution to the US-Iran war has slipped further out of sight, and investors are entering a period of seasonal weakness in equities.
Here’s the bull and bear case for investing in stocks right now, according to the top voices in markets.
The bulls say…
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Rate-hike fears are diminishing
Investors have dialed back the odds of a rate hike this year, given cooler inflation data, brightening the outlook for stocks in the second half.
The annual inflation rate cooled slightly to 3.4% in the month of July, in line with expectations. Producer prices were unchanged last month, falling short of expectations for a 0.2% monthly increase.
Investors are pricing in a 37.8% chance the Fed will leave rates unchanged through the end of the year, up from 22.9% a week ago, according to the CME Fedwatch tool.
“Disinflationary trend is in place and the Fed is unlikely to hike,” strategists on JPMorgan’s market intelligence team wrote of the bull case in a recent note to clients.
Bull market confirmation
The bull market has also been “confirmed” by new record highs in the major indexes, according to an analysis by Bespoke Investment Group.
Small-caps, mid-caps, and large-caps are now all trading around all-time highs, the Nasdaq 100 being the one exception out of the universe of large-cap stocks, the research firm wrote in a note.
Stellar earnings growth
Earnings growth has been phenomenal for the quarter. Of the S&P 500 firms that have reported earnings so far, 86% have beaten earnings-per-share expectations, according to the latest update from FactSet.
The benchmark index is on track to see a blended earnings growth rate of 50.4%, the highest pace of growth seen since 2021, the firm added.
“This market has really been underpinned by the earnings story, and this quarter came in well beyond what many of us expected,” Mona Mahajan, the head of investment strategy and asset allocation at Edward Jones, wrote in a note on Friday. “There was concern around the AI trade coming into earnings season, but a lot of that concern has been alleviated, and we think there is likely still room to run.”
The US economy remains resilient
Adding to the bull case is a resilient US economy. GDP growth is on track to come in at around 2% for the quarter, JPMorgan strategists wrote on Friday.
“We think the Bull Case is most accurate and remain Tactically Bullish,” the bank said. “Add in strong earnings where analysts are increasing estimates into year-end, accommodative positioning, and you have the basis for the continuation of the bull market.”
The bears say…
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Investors are too exuberant
Bullish sentiment is at extreme levels that, historically, has preceded weakness in stocks.
Bank of America’s Bull & Bear Indicator — its widely followed contrarian gauge that flashes a “sell” signal when investors are extremely bullish, and vice versa — rose to a level of 9.6 in late July, its strongest “sell” reading since 2021, strategists wrote in a note.
Following the 17 sell signals that have been triggered since 2002, global stocks have seen an average drawdown of 2%-3% in the three months that followed, with the maximum drawdown ranging from 15%-20%, a team led by the bank’s Michael Hartnett said.
Markets are heading for seasonal weakness
The late summer kicks off what is often the worst three-month stretch of the year for markets.
Historically, US stocks have seen the weakest return from the August to October period, with the S&P 500 posting an average loss of 0.02% in that time frame since 1928, according to an analysis from Bank of America.
The period typically favors a “defensive bias” among investors, the bank wrote last month.
Stocks have also been historically weak in the months leading up to midterm elections. In all midterm years since 1974, the S&P 500 has seen a median return of 0% from August 1 through election day in November, strategists at Goldman Sachs wrote in a recent note.
Investors are also eyeing the Fed’s annual symposium at Jackson Hole, an event that has been known to provoke fresh volatility as traders digest guidance on where interest rates might be headed.
Last year, the major indexes enjoyed a strong rally after former Fed Chair Jerome Powell spoke at Jackson Hole, with the Dow soaring more than 800 points as investors took in updated policy guidance.
The year prior, however, stocks tanked, with the Nasdaq shedding more than 1% following Powell’s speech.
Earnings growth could slow
Strong earnings have been the engine that’s powered the stock market in recent weeks. Yet, there’s a growing risk that expansion will start to slow, according to Jim Paulsen, a Wall Street economist and the former chief investment strategist at the Leuthold Group.
Paulsen recently pointed to various signals that earnings growth could soon fall, such as corporate profit margins approaching historical extremes and cyclical stocks underperforming in recent weeks.
“Contemporary stock market bullishness is being driven primarily by incredible profit momentum,” he wrote, raising questions about whether that momentum is sustainable, particularly “relative to rising expectations.”
