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(Source: Nasdaq)
If history is any guide, the rally that has taken the U.S. stock market to record highs this week may have a long way to go.
Fresh signs of a cooling economy eased concerns about inflation in May, helping all three major U.S. stock indexes hit records this week. The benchmark S&P 500 Index (.SPX), opens in new tab, which fell more than 4% in April, is now up 11% so far this year.
Market strategists who follow historical trends say stocks tend to build momentum when recovering from pullbacks of similar size, and often continue to rise even after regaining lost ground.
If the current bounce fits that pattern, more gains could remain. The S&P 500's previous rebounds after 5% declines have been followed by an average gain of 17.4%, said Keith Lerner, co-chief investment officer at Truist Advisory Services. As of Friday, the index had risen nearly 7% from its April lows.
"Once the bottom is found, the market generally has to move further than we've seen so far," said Lerner, who studied data going back to 2009.
Broader historical comparisons also suggest more upside to the current bull market. Lerner's study showed an average 108% gain for bull markets since the 1950s, compared to nearly 50% the S&P 500 has gained since October 2022.
At the same time, the average duration of a bull market in that period has been just over 4.5 years, compared to just over 1.5 years since the start of the current one, Lerner data showed.
Investors have pointed to renewed optimism that the economy is headed for a so-called soft landing and projections of strong earnings as factors that could drive further gains in stocks.
Market momentum will be tested on Wednesday when semiconductor giant Nvidia (NVDA.O), whose shares have soared on enthusiasm for artificial intelligence, reports its quarterly results.
Investors are also watching next week's durable goods and consumer confidence data for further signs of whether growth is cooling enough to support the case for interest rate cuts this year.
LET THE 'WINNERS TRAVEL'
Traders work on the floor of the New York Stock Exchange in New York
Traders work at the New York Stock Exchange (NYSE) in New York City, U.S., May 17, 2024. REUTERS/Brendan McDermid/File Photo License rights purchase, opens new tab
Momentum can also be a factor in the performance of various areas of the market after a rally, said Sam Stovall, chief investment strategist at CFRA.
The S&P 500 sectors that led when stocks recovered from a pullback outperformed the broader market 68% of the time as stocks continued to rise, said Stovall, who studied 35 market rebounds since 1990.
The main takeaway: "After recovering from a setback, you want to let the winners move forward," Stovall said.
Technology (.SPLRCT), opens in new tab, utilities (.SPLRCU), opens in new tab, and real estate (.SPLRCR), opens in new tab have been the leading sectors in the market's most recent rally, with increases of 11.3%, 10.1% and 7.9%. % respectively.
Investors who study chart patterns to spot market trends also see evidence that strong momentum could keep stocks buoyant.
All 11 S&P 500 sectors are currently above their 200-day moving averages, said Willie Delwiche, independent investment strategist and business professor at Wisconsin Lutheran College.
When at least nine of the sectors are above those trend lines, the S&P 500's average annual return since that point has been 13.5%, Delwiche found.
Of course, a number of factors could throw the stock off its trajectory. While recent data has shown a calm in consumer prices and a moderate slowdown in labor markets, signs that the cooling trend is not gaining ground could renew concerns about an overly strong economy forcing the Federal Reserve to keep rates high or even raise them again.
Despite the encouraging data, Fed officials have not openly changed their minds yet on the timing of the rate cuts that many investors are convinced will begin this year.
Many stocks also have lofty valuations: The S&P 500 trades with a forward price-to-earnings ratio of 20.8, well above its historical average of 15.7, according to LSEG Datastream.
Political uncertainty stemming from the U.S. presidential election, as well as the risk of conflict in the Middle East and Ukraine, could also spur volatility this year, analysts at Deutsche Bank said in a note on Friday.
"The manual is for sharp but short-lived selling, in which the economic context will eventually dominate," wrote the bank's strategists, who nevertheless believe that the S&P 500 could rise another 4% approximately to 5,500 this year.
Source: Reuters (Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Richard Chang)
