Will The Risk On Party Dominate the Second Half of the Year?

Jared Blikre of Yahoo reports blistering stock returns this year make case for a strong second half:

Stocks made little noise during a holiday-shortened session on Monday.

Investors will return for a full trading day Wednesday with a focus still firmly on how the second half of 2023 will unfold.

And folks would be forgiven for expecting some bearish mean reversion in the months ahead. But after slicing and dicing the outsized returns from the first and second quarters, our work shows the tape clearly showing history is with the bulls.

Looking back over the prior 95 years of history for the S&P 500 (^GSPC), in 61 years returns in the first half were positive.

In 28 years — or nearly half the time — the index posted double-digit percentage gains, including this year which saw the index rise 16% to start the year. And in these years, the second half returned, on average, 6% with a win rate of 75% and an average Sharpe ratio of 0.87. The median return after these years was a more robust 9.7%.

S&P 500 Returns After 10% Surge in First Half of Year
S&P 500 Returns After 10% Surge in First Half of Year

Looking only at the first six-month returns following a year of negative results — which includes this year — improves the odds.

In those ten years, the average second-half return was 9.8%, the median return 11.5%, the win rate at 80%, and an enviable average Sharpe ratio of 1.82. Of course, this does suggest that mean reversion is alive and well, but on an annual rather than semi-annual timeframe.

The nuanced results for the S&P 500 presented here are a bit different than those we found for the Nasdaq Composite (^IXIC), which appears to have an aversion to results that are simply "too good."

With the S&P 500, we didn't find significant edges to be found by filtering for the total number of positive days or total days above the 10-day moving average.

Nevertheless, the bottom line for investors is that the strength we've seen so far this year tends to beget more strength. At least when it comes to the S&P 500.

Seasonal tailwinds can account for up to a third of an instrument's returns, meaning the ultimate direction for major indices are still overwhelmingly based on the fundamentals du jour.

Accordingly, we'll still be tracking the Fed's favorite economic reports and second-quarter earnings this month with bated breath.

But those who ignore history, in markets or otherwise, do so at their own peril.

Lewis Krauskopf, Bansari Mayur Kamdar and Johann M Cherian of Reuters report Wall St ends slightly higher in shortened session, Tesla jumps:

Wall Street's main indexes ended with slim gains in a holiday-shortened session on Monday, helped by a surge in Tesla and strength in bank shares as the second half of the year kicked off on a subdued note.

Tesla (TSLA.O) shares jumped 6.9% as the electric vehicle maker said it delivered a record number of vehicles in the second quarter.

Shares of major banks gained after the companies raised dividends as they sailed through the Federal Reserve's annual health check. Wells Fargo (WFC) shares rose 1.7%, Citigroup (C) shares climbed 1.5%, while the S&P 500 banks index (XBK) ended up 1.5%.

Trading volumes were lighter than average as the stock market closed at 1 p.m. ET ahead of the July 4th Independence Day holiday on Tuesday.

"You have got a lot of people that are just not in the market today," said Chuck Carlson, chief executive at Horizon Investment Services in Hammond, Indiana. "Nobody is really placing any big bets on either side of the market right now."

The Dow Jones Industrial Average rose 10.87 points, or 0.03%, to 34,418.47; the S&P 500 gained 5.21 points, or 0.12%, at 4,455.59; and the Nasdaq Composite added 28.85 points, or 0.21%, at 13,816.77.

While nine of the 11 S&P 500 sectors rose, healthcare (XLV) fell the most, dropping 0.8%, while the heavyweight technology sector (XLK) fell 0.3%.

Stocks ended higher on Friday, closing out a strong first-half of the year for major equity indexes. The Nasdaq Composite posted its biggest first-half gain in 40 years, rising 31.7%.

Outsized gains for megacap stocks have led indexes this year, but recent signs have shown a broadening rally.

"You have a stronger market and the likelihood of a more sustained upside move when you have broader strength," Carlson said.

A widely watched section of the U.S. Treasury yield curve hit its deepest inversion on Monday since 1981, reflecting financial markets' concerns about the economy.

U.S. manufacturing slumped further in June, a survey showed, reaching levels last seen when the economy was reeling from the initial wave of the COVID-19 pandemic.

Advancing issues outnumbered decliners on the NYSE by a 2.27-to-1 ratio; on Nasdaq, a 1.51-to-1 ratio favored advancers.

The S&P 500 posted 20 new 52-week highs and no new lows; the Nasdaq Composite recorded 59 new highs and 47 new lows.

About 6 billion shares changed hands in U.S. exchanges, compared with the 11 billion daily average over the last 20 sessions.

And Karen Friar and Myles Udland also report stocks rise, EV names rally ahead of holiday break: Stock market news today:

Stocks rose slightly on Monday with all three major indexes logging gains but none rising more than 0.21% during a shortened trading session that came ahead of the July 4th holiday.

When the closing bell rang on Wall Street on Monday, the S&P 500 was up 0.12%, the Dow Jones Industrial Average higher by 0.03%, and the Nasdaq Composite was up 0.21%.

Shares of Tesla (TSLA) rose nearly 7% on Monday after the electric-vehicle maker's second-quarter production and delivery numbers — which reflect sales numbers — hit all-time records.

EV names including Li Auto (LI), Nio (NIO), XPeng (XPEV), and Rivian (RIVN) were also higher on Monday.

Stocks in the US will re-open for trade on Wednesday, July 5 with a busy economic calendar and a crucial June jobs report awaiting investors over the week's final three trading days.

Tom Lee raises S&P 500 price target to 4,825

In a note to clients published late Sunday, Fundstrat's Tom Lee revised up his already bullish outlook for the S&P 500, pushing his year-end price target to 4,825 from 4,750.

And one crucial thing in Lee's update stood out to us — the call is not about AI.

Tech's centrality to this year's rally cannot be ignored. But Lee does not see AI as a big part of his increasingly constructive view on stocks. Falling inflation, an economy unlikely to tip into recession, and earnings estimates that are beginning to rise are at the heart of Lee's outlook.

Folks who follow Wall Street strategists closely will know Lee has long been among the more ardent bulls on the Street, both in this environment and others. As far back as August 2022 we were writing about Lee's increasingly optimistic outlook for the stock market.

At the time, Lee was bracing for a Fed pivot and rapid market reversal similar to what markets experienced in 1982. And though this dynamic has not quite played out, Lee again noted on Sunday how quickly stocks can be to price in a shift from the Fed. The summer of '22 call was too early, but the speed with which stocks are eager to price in a Fed pivot has featured in this year's rally.

Manufacturing data sours last week's economic story

The manufacturing sector stumbled in June, casting some doubt on the economic revival story told by last week's rush of data.

Readings from S&P Global and the Institute for Supply Management (ISM) out Monday showed a sharper contraction in manufacturing activity last month.

S&P's PMI reading for the month came in at 46.3 while ISM's reading came in at 46.0; for both measures, readings above 50 indicate expansion in activity while readings below indicate a contraction. In May, S&P's reading registered a 48.4 while ISM's index came in at 46.9 last month.

"Demand remains weak, production is slowing due to lack of work, and suppliers have capacity," said Timothy Fiore, chair of the ISM's manufacturing business survey committee. "There are signs of more employment reduction actions in the near term. Seventy-one percent of manufacturing gross domestic product (GDP) contracted in June, down from 76 percent in May."

Chris Williamson, chief business economist at S&P Global Market Intelligence, said, "The health of the US manufacturing sector took a sharp turn for the worse in June, adding to concerns over the economy potentially slipping into recession in the second half of the year."

Here we are entering the second half of the year and while a US and global recession are imminent, so far this year, markets have been flying higher thanks to a few megacap tech stocks:

Think about it, in six months, the Nasdaq 100 is up 40% and it's mostly due to seven stocks: Apple, Amazon, Google, Microsoft, Metaverse, Nvidia and Tesla:

But there are plenty of other stocks participating in this Risk On rally, just to show you a few below:

And if you really drill down and look at the Nasdaq over the last six months, you'll see some spectacular performers, mostly small cap tech stocks and biotechs (see full list here):

So what gives? How can Apple, Microsoft and Nividia be making new highs and Risk On is still dominating the market when we are about to enter a major recession?

A few things are going on:

  • Positioning and herding: The bulls are using all their might to squeeze out bears and create major FOMO so portfolio managers that were positioned defensively going into 2023 are now forced to chase high-flyers higher. And it's not really "bulls", it's elite hedge funds and some very powerful mutual funds and indexers with active strategies behind this nonsense, much like in 1999-2000.
  • Too much money: There is still way too much money in the market, way too much, so every dip is being bought hard. This is the after-effect of ultra loose monetary and fiscal policy in response to the pandemic.
  • Economy remains resilient: The biggest thing, however, is we have yet to see material weakening of the US economy which leads the world. You'd think after a year and a half and aggressive rate hikes, the US economy will finally succumb.

Well, on the last point, it's happening but labor always goes last, so by the time the unemployment rate surges, it's too late, the earnings recession will send stocks a lot lower before.

No doubt, momentum has favored the bulls and Risk On trades but now more than ever is a time to focus on risk.

Why? I've explained all this in two recent comments on how the absolutely insane (AI) market has reached new levels of delusion and  why the worst isn't behind us, it lies straight ahead.

I know, once the Nasdaq surges 40% in six months, it's game over, the bulls win but I would be very careful thinking that stocks will end the year on a high note.

The biggest risk remains concentration risk and when all those elite hedge funds pull the plug and sell the "Magnificent Seven," a powerful beta storm will annihilate all stocks.

"Rubbish! Tesla keeps grinding higher and higher, the market doesn't care about Jerome Powell and other central bankers. Just keep buying Apple, Microsoft, Nivia and other top performers."

You keep telling yourself that but when this market craters, it will be merciless and too late.

And it will impact all sectors, including some that did very well last quarter:

Everyone feels rich, taking cruises, flying on airlines and buying homes, totally impervious to the rise in rates:

But once it becomes clear the economy is slowing markedly all over the world, reality will set in, a nasty earnings recession will clobber the market to fresh new lows.

This is just a matter of when, not if.

Any idiot who thinks the Nasdaq can keep going exponentially never lived through the tech bubble and doesn't remember what happened in 1987 or 2008.

This is why Bank of America's Michael Harnett thinks stocks are headed for collapse and that the recent jump represents a “big rally before big collapse”:

Of course, big banks have thus far been able to hide the extent of the damage from the ongoing commercial real estate crisis.

Come this fall, they will not be able to do this, and al hell will break loose in credit markets.

So to all my friends who keep pestering me "just buy Apple, just buy Tesla, just buy Microsoft, etc." I wish you all well because when this market turns on a dime, you will not have the chance to get out (even though many of you think you will and are already dreaming of "buying the dip"). 

This is a very sick market in many ways, if you don't respect that, you will lose your shirt.

When the beta storm hits, it will take down all sectors, not just the high-flyers.

That's why I don't believe 2023 will end up being the biggest outlier ever, and I say this knowing full well I've made spectacular gains this year, trouncing the Nasdaq and Magnificent Seven BS stocks (taking huge risks, of course).

Here is some more food for thought:

One fixed income trader I respect shared this with me:"The pain trade is higher for many reasons. If nothing serious happens between now and August I think we might a significant pop higher."

Another friend of mine thinks FOMO is so strong this year that it will continue propping risk assets higher. I replied:

"All I know is higher stock market goes, more aggressive Fed will be and worse the eventual bear market will be. Looking a lot like 1999-2000 here.

China is slowing and that’s why oil prices continue to plunge despite OPEC’s output cuts. Oil and copper are telling you recession is right around corner

Anyway, we are entering the second half of the year and come October, I suspect it will be clear that the Risk On party is most definitely over.

Below, Tom Lee, Fundstrat co-founder, joins 'Closing Bell' to discuss his bullish outlook on the market and where he sees markets going in the second half.

And Meera Pandit, JPMorgan Asset Management global market strategist, joins 'Squawk Box' to discuss the latest market trends, the Fed' rate hike campaign, upcoming earnings season, and more.

Third, Mohamed El-Erian, Allianz chief economic advisor and president of Queens' College, Cambridge, joins 'Squawk Box' to discuss the Fed's rate hike campaign its impact on the U.S. economy, China's economic recovery, and more. 

Fourth, my favorite CNBC commentator, Short Hills Capital's Steve Weiss, throws in the towel stating maybe this time is different and markets don't care if the Fed and other central banks are hiking rates. 

With all due respect to Steve Weiss, he lost all credibility for me stating this nonsense at this time and will sorely regret it come the end of the year (have a spine, do not let FOMO dictate your thoughts). 

Sixth, Jeremy Siegel, Wharton Business professor, joins 'Closing Bell' to discuss the Nasdaq, the tech rally and the Fed. 

Lastly, on this episode of Odd Lots, they speak with co-CIO Greg Jensen about both the possibilities and limitations of the AI advances. They also discuss markets and macro, and why he believes that investors are still too optimistic about the Federal Reserve's ability to get inflation back to target.