By Lewis Krauskopf
NEW YORK (Reuters) – A recovery that has taken the U.S. stock market to record highs this week could continue, if history is any guide.
Fresh signs of a cooling economy calmed inflation worries in May, sending all three major U.S. stock indexes soaring to records this week. The benchmark S&P 500, which fell more than 4% in April, is now up 11% this year.
Market strategists who track historical trends say stocks tend to build momentum as they recover from similar declines, often continuing to rise even after making up lost ground.
If the current rebound were to stick to that pattern, even more gains could be in store. Previous rebounds in the S&P 500 after a 5% decline have been followed by an average gain of 17.4%, said Keith Lerner, co-chief investment officer at Truist Advisory Services. On Friday, the index was almost 7% higher than the April low.
“Once you find the bottom, the market typically has further to go than what we’ve seen so far,” said Lerner, who studied data from 2009.
Broader historical comparisons also point to more upside potential for the current bull market. Lerner’s research shows that bull markets have risen an average of 108% since the 1950s, compared to the nearly 50% gain that the S&P 500 has gained since October 2022.
At the same time, the average duration of a bull market during that period was just over 4.5 years, compared to just over 1.5 years since the start of the current one, Lerner’s data showed.
Investors have pointed to renewed optimism that the economy is heading for a so-called soft landing and forecasts for strong earnings as factors that could fuel more gains in stocks.
The market’s momentum will be tested on Wednesday when semiconductor giant Nvidia – whose shares have soared on enthusiasm about artificial intelligence – reports quarterly results.
Investors will also be looking at durable goods and consumer confidence data next week to see if growth cools enough to support the case for rate cuts this year.
LET ‘WINNERS RIDE’
Momentum can also be a factor in how different parts of the market perform after a recovery, says Sam Stovall, chief investment strategist at CFRA.
S&P 500 sectors that led the way as stocks recovered from a pullback outperformed the broader market 68% of the time as stocks continued to climb higher, said Stovall, who has studied 35 market rebounds since 1990.
The key takeaway: “After recovering from a setback, you want to let your winners ride,” Stovall said.
Technology, utilities and real estate were the top sectors during the market’s most recent recovery, up 11.3%, 10.1% and 7.9% respectively.
Investors who study chart patterns to spot market trends also see evidence that strong momentum can keep stocks afloat.
All eleven S&P 500 sectors are currently above their 200-day moving averages, says Willie Delwiche, an independent investment strategist and business professor at Wisconsin Lutheran College.
When at least nine of the sectors are above these trend lines, the average annual return for the S&P 500 from then on is 13.5%, Delwiche notes.
Of course, a number of factors can throw stocks off track. While recent data shows that consumer prices have fallen and there is a moderate slowdown in the labor market, signs that the cooling trend is not gaining momentum could be concerns about an overly strong economy forcing the Federal Reserve to keep rates high or even to raise again, revive.
Despite encouraging data, Fed officials have not yet publicly changed their views on the timing of the rate cuts that many investors are convinced will begin this year.
Many stocks are also highly valued: The S&P 500 trades at a price-to-earnings ratio of 20.8, well above the historical average of 15.7, according to LSEG Datastream. Political uncertainty from the U.S. presidential election and the risk of conflict in the Middle East and Ukraine could also fuel volatility this year, Deutsche Bank analysts said in a note Friday.
“The playbook is for a sharp but short-lived sell-off, with the economic context ultimately dominating,” wrote the bank’s strategists, who nevertheless believe the S&P 500 could rise another 4% or so to 5,500 this year.
(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Richard Chang)
