A rebound that has taken the U.S. stock market to record highs this week may have further to run, if history is any guide.
Fresh signs of a cooling economy calmed inflation worries in May, helping all three major U.S. stock indexes rise to records this week. The benchmark S&P 500, which fell over 4% in April, is now up 11% year-to-date.
Market strategists who track historical trends say stocks tend to build momentum when recovering from similar-sized pullbacks, often continuing to rally even after making up lost ground.
Should the current bounce conform to that pattern, more gains could be in store. Past rebounds in the S&P 500 from 5% pullbacks have been followed by a median gain of 17.4%, said Keith Lerner, co-chief investment officer at Truist Advisory Services. As of Friday, the index was up nearly 7% from its April lows.
“Once you find the low, the market typically has further to go than what we’ve seen so far,” said Lerner, who studied data going back to 2009.
Broader historical comparisons also suggest more upside ahead for the current bull market. Lerner’s study showed a 108% median climb for bull markets since the 1950s, compared to the nearly 50% the S&P 500 has gained since October 2022.
At the same time, the median length for a bull market in that period has been just over 4.5 years compared to slightly more than 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 projections for strong earnings as factors that stand to fuel more gains in stocks.
The market’s momentum will get a test on Wednesday when semiconductor giant Nvidia – whose shares have soared on enthusiasm over artificial intelligence – reports quarterly results.
Investors are also watching durable goods and consumer sentiment data next week for further signs of whether growth is cooling enough to support the case for interest rate cuts this year.
LET ‘WINNERS RIDE’
Momentum can also be a factor in how various areas of the market perform following a rebound, said Sam Stovall, chief investment strategist at CFRA.
S&P 500 sectors that led as stocks rebounded from a pullback outperformed the broader market 68% of the time as equities continued running higher, said Stovall, who studied 35 market rebounds since 1990.
The main takeaway: “Following recovery from a pullback, you want to let your winners ride,” Stovall said.
Technology, utilities and real estate have been the top sectors in the market’s most recent rebound, rising 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, an independent investment strategist and business professor at Wisconsin Lutheran College.
When at least nine of the sectors are above those trendlines, the average annual return for the S&P 500 from that point has been 13.5%, Delwiche found.
Of course, a range of factors could throw stocks off their trajectory. While recent data have shown calming consumer prices and a moderate slowdown in labor markets, signs that the cooling trend is not gaining traction could renew worries about an overly strong economy that forces the Federal Reserve to keep rates elevated or even raise them again.
Despite encouraging data, Fed officials have not openly shifted views yet about the timing of rate cuts that many investors are convinced will start this year.
Plenty of stocks are also at lofty valuations: the S&P 500 trades at a forward price-to-earnings ratio of 20.8, well above its historic average of 15.7, according to LSEG Datastream. Political uncertainty from U.S. presidential elections as well as risk from conflicts in the Middle East and Ukraine could also spur volatility this year, Deutsche Bank analysts said in a Friday note.
“The playbook is for sharp but short-lived sell-offs, with the economic context eventually dominating,” wrote the bank’s strategists, who nevertheless believe the S&P 500 could rise another roughly 4% to 5,500 this year.
