Will Stocks Crash in August?

Stocks traded flat this morning following a major two-day run-up in the sessions prior. Worse-than-anticipated weekly jobless claims (419,000 reported vs. 350,000 expected) initially gave bulls pause when the market opened. Longer-term Treasury yields retreated in response.

“There’s no question that the jump in jobless claims is an unwelcome surprise and a dent to momentum for continued improvement on the jobs front,” explained Mike Loewengart, managing director of investment strategy at E-Trade.

“The disappointing number may cause an initial shock to the system, but many could view this as short-term volatility in the labor market until we see benefits start to expire. For the most part, the market has shaken off Monday’s sell-off in favor of strong earnings, so market watchers could see the forest from the trees in this scenario.”

But did earnings really cause the market’s rapid rebound? Or was it simply bargain-hunting traders doing some dip-buying?

Just as we predicted last week, tech stocks have done quite well despite the recent selling. Tech firms tend to be primarily growth-focused. And because of this, growth stocks enjoy falling long-term yields.

That’s helped tech become the market’s most defensive sector in July, with the sector’s top names overachieving. Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), and Amazon (NASDAQ: AMZN), for example, are all up significantly on the day despite the S&P’s muted gain.

It’s also the kind of thing that happens as the market approaches the “dog days of summer” – a period in which the market has historically seen profit-taking.

“The truth is investors have been very spoiled by the recent stock market performance,” said LPL Financial chief market strategist Ryan Detrick.

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“Incredibly, we haven’t seen as much as a 5% pullback since October. Although we firmly think this bull market is alive and well, let’s not fool ourselves into thinking trees grow forever. Risk is no doubt increasing as we head into the troublesome August and September months.”

Detrick’s absolutely right. The market’s running on an unprecedented wave of bullish exuberance. CIC Wealth executive vice president Malcolm Ethridge believes it’s only a matter of time until a major correction rocks equities, though.

“The market is playing this collective game of chicken right now,” Ethridge remarked.

“We all collectively agree that we can’t go on this way for much longer. There’s no obvious catalyst.”

The Covid delta variant seemed like a potential candidate for sparking a sell-off. But according to Jun Bei Liu, portfolio manager at Tribeca Investment Partners in Sydney, delta shouldn’t shift sentiment in a meaningful way.

“The market suddenly became worried about the delta variant and how it might affect the path to recovery,” she said.

“But what we have compared with 12 months ago is quite a few viable vaccines […] eventually we will be coming out of this and we are much closer to the end than we were 12 months ago.”

Bei Liu added that “Every now and then investors look for reasons to take some profits off and that’s what we saw.”

That certainly seemed to be the case following Tuesday’s snap-back rally. And though stocks are trading flat today, the ongoing recovery may not be finished simply because the market’s true driver of sentiment remains perfectly intact:

The Fed’s continued bond-buying programs, otherwise known as quantitative easing (QE).

With QE still in full force and no indication that the Fed will reduce it at any point, there are likely several more weeks’-worth of gains ahead. The next FOMC meeting takes place in mid-August. No “taper talk” (or “taper tantrums,” for that matter) should occur until then.

On Monday, we suggested that dip-buying might be a wise choice. It turned out to be the smart move just one day later.

Now, simply holding on may prove to be just as prudent even if stocks end up flattening out (or dropping slightly) to finish out the week.

Because until the FOMC meets next, the Fed will continue to “backstop” the market just as it’s done in the past. The practice of doing so gave bulls the “green light” to buy every dip that came along in 2021. Moving forward, this behavior should persist (if not intensify) as Fed Chairman Jerome Powell finds new reasons to keep QE deployed in full force.

Including, but not limited to, a sudden uptick in Covid infections.

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