Will There Be A Second Quarter Rally? Stock Talk Podcast

As I write this, the tax season is behind us, and we are into earnings season. It’s a Friday, and we look to be in the midst of some margin calls and forced selling in the market. This looks to be caused by collateral damage being done in the Treasury bond market as the market peaked Thursday morning almost to the minute as Fed Chairman Powell, was interviewed, and paid tribute to previous Fed Chairman, Paul Volker’s actions, in the 1970s to stop high inflation.  The market proceeded to drop almost in a straight lone from 4510 to 4275 or almost 5.25% in less than 2 trading days. 

The stock buyback window for equities is almost entirely closed right now.  This contributed to the heavy selloff, as companies are not in the market bidding for their own stocks on weakness.  However, buybacks should build in the coming weeks in May and June after companies report earnings. The S&P500 sits at 4275ish. Overall, if you turn on the news, one gets the impression that the overall stock market should not be where it is. Many suggest it should probably be materially lower already, despite overall earnings estimates rising for the S&P500.   

We wanted to provide a little data dispelling that notion. Additionally, we want to add a little data of optimism for the remainder of the second quarter with the important disclosure that our team still expects, overall, the markets to remain choppy and sloppy and very messy through the third quarter of the year.  We’ve detailed why numerous times since early November of last year.  Check out our previous YouTube videos if you are interested in more of that detail. 

I am Chris Perras with Oak Harvest Financial in Houston and welcome to our weekly stock talk podcast.  Before we get into this week’s topic titled, “Late 2nd Quarter rally? That’s the norm”, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads new content. 

As we have previously discussed, in the first quarter of the year, the overall S&P500 sustained its first intra-quarter correction, universally defined as a decline of -10-20% in price, since our Covid lows in late March 2020. The NASDAQ composite index fell within a whisker of its own “bear market” defined as a greater than -20% loss using market close prices.  That was the bad news.  The good news is that had you not panicked at the worst time, on or near the lows which is also when most investors anxiety is highest, and had you stayed pat in your overall indexes or strategies that you designed with your financial advisor, you probably didn’t blow up your long-term financial plan. Why? Because those two indexes, the S&P500 and Nasdaq composite then violently rallied almost in a straight line into quarter end.  The final tally on the S&P500 was down about -5% in total return.  The NASDAQ composite first quarter decline amounted to about -10%.  It was a first quarter that was a sloppy, choppy mess led by large and violent sector rotations. 

While there is likely to be lots more indecision and emotion in the markets the next 4 to 6 months, there are reasons to believe that a normal S&P500 rally, over the second half of the second quarter could be in the cards, before once again, succumbing to some overall market weakness in the third quarter. 

If you want to watch another strategist’s version of our second quarter messaging, here’s a link to a recent CNBC video detailing technician and market historian Larry Williams thoughts on the odds of a possible second half 2nd quarter rally.  For what it’s worth, Mr. Williams was the first of very few commentators to call the Covid lows precisely and accurately in late March of 2020. He was also the first to lay out the markets path back to new all-time highs.  He’s been doing this for decades.  He’s got a great track record and our team listens to his market commentary because he rarely makes new forecasts. In other words, “when Larry talks, it has paid to listen”.  Viewers, remember though, no forecast or strategist is perfect and past performance is no guarantee of the future in the stock market. 

First viewers, many strategists on TV argue or state that the markets “can’t” rise when the Federal Reserve is raising interest rates and or moving toward “QT”, which is short for quantitative tightening or the action of the Fed shrinking its balance sheet.  This of course is factually and historically, incorrect. You can go to the Federal Reserve Saint Louis website and graph the historical relationship yourself, but we are doing it for you.  This is a chart showing the historical relationship between the SP500 and the Fed Balance sheet.   

As one can see, post the early 2018 Trump Tax cut passage in first quarter of 2018, the Federal Reserve was both raising rates and beginning to, net, shrink their balance sheet.  The stock markets initially sold off hard in the first quarter of 2018, much as they have this year.  However, the S&P500 then proceeded to slowly recover and lurch and grind its way higher, to making marginal new all-time highs in the summer of 2018. Of course, the markets then once again succumbed to Federal Reserve hawkish monetary policy actions and commentary in the 4th quarter of 2018 and declined into Xmas Eve in late December. 

A second argument one might hear about is that investor sentiment is horrible.  We’ve discussed this one in the past.  Viewers, investor sentiment is best viewed as a contrary, not confirming, indicator in the overall stock markets.  Two weeks ago, AAII bullish sentiment hit its lowest level since 1992.  This is a 30-year low.  Here is the chart.  

As one can see from the next table, the 3-month forward return of the SP500 has been positive 11 out of 14 time periods when investors have been this negative emotionally.  Moreover, since the great financial crisis ended in 2009, the 3-month forward return has ranged from +37.5% to +5.75%. Taking the low end +5.75% return would yield a 2nd quarter rally and peak back around 4600.  Taking the average, would push the number well above 4700 on the S&P500. 

A third data series arguing for a late second quarter rally, is that we are currently in a US Presidential Cycle, midterm election year.  As first previewed last November, midterm years have historically coincided with higher stock market volatility and market corrections.  The average midterm correction this cycle, since 2009, has been about 14.5%.  We dropped roughly 13.5% on the S&P500 in the first quarter and as of Fridays close the S&P500 sits down about -11%.  Data from Merrill Lynch has the average move from the markets lows through year end, over the last 21 mid-term years, being roughly +17.6%.  Such a return would place the SP500 at new all-time highs into year end. 

Finally, the fourth and final data series I will mention is one we track in real time.  What’s that?  Forward stock volatility.  That’s the cost of insuring your portfolio in future months. The math says, that a rally higher, call it approaching 4650-4700 into late June early July, which would be between +7.5-10% as of this writing, requires spot  market volatility to reach 20 sometime out in June. Viewers, that is where is volatility was sitting 2 weeks ago, in the midst of early second quarter Federal Reserve hawkish talk, the midst of Russia continuing to bomb Ukraine, in the midst of early season earnings disappointments by the likes of JP Morgan and Netflix, and also as  long term interest rates first  approached 3%.  All of these events, took place while companies were locked out of the market for buying back their own shares.    

Viewers a lurch and grind higher in the overall market would not be “unprecedented” over the next 2 months.  Far from it.  It would be quite normal by historical standards and the data we follow, even during Federal Reserve tightening cycles. It would be one of those “climb the wall of worry” moves higher that one has come to expect since the great recession ended in 2009, that bears hate, and few expect. 

We continue to expect more volatility in the upcoming second and third quarters, around which we are likely to make moves around the edges when we find value in single stocks or sectors.  For now, our work continues to show us in a corrective period in both price and time. We continue to believe this should end later in the 3rd quarter, and then the overall market resumes the ongoing bull market in the 4th quarter of 2022 through the first half of 2023. 

At Oak harvest, we think our clients are best served by us helping them plan for their future needs and risks, instead of focusing on the past. Our crystal ball is far from perfect, nor is anyone’s, which is why our advisors and retirement planning teams plan for your retirement needs first, and your greed’s second. 

Give us a call to speak to an advisor and let us help you craft a financial plan that is meets your retirement goals. Call us at (877) 896-0040, we are here to help you on your financial journey into and through your retirement years.