A breather in the market rally may be healthy and an opportunity

DEWITT, Mich. - Aug. 15, 2023 - PRLog -- Some caution after a strong rally seems reasonable here

After a remarkably strong rally to start the year, markets have given back a bit in August thus far, with the S&P 500 down around 3% since its recent high on July 31. Underneath the surface, however, we see the Nasdaq is down over 4.0% during this period, and the "Magnificent 7" large-cap stocks are down over 5.0%. The parts of the market that have led the way higher are now perhaps taking a breather, which we view as a healthy development as investors digest outsized gains.

In our view, some caution is likely prudent after a nearly 18% rally in the S&P 500 and a 30% move higher in the Nasdaq from March through July*. Particularly as we head into August and September, which tend to be more volatile months in markets, we could see a more traditional correction in the 5% - 10% range emerge in markets. However, we don't see a correction derailing what we believe is the early stages of a longer-term bull market, particularly as many fundamentals around inflation, interest rates, and the economy continue to support a better backdrop for financial markets ahead.

The good news is that the market rally has been underpinned by better fundamentals

The market rally in its early stages was driven by enthusiasm around artificial intelligence (AI) and was led largely by mega-cap technology. More recently, however, the rally has broadened, with leadership coming from cyclical sectors and even rebounds in small-cap stocks and international equities. This occurred as markets climbed several walls of worry, particularly around inflation, the Federal Reserve and the broader economy:

• The Fed seems likely to remain on hold for now: After the relatively benign inflation data last week, markets continue to expect the Fed to remain on hold through 2023. In our view, this is a credible scenario, and, barring any inflation shocks, we would expect the Fed to hold the fed funds rate at the current 5.25% - 5.5% for an extended period. We would, however, expect the Fed to leave the door open to additional rate hikes if needed and message this consistently. But overall, the next move by the Fed, perhaps in the first or second quarter of 2024, could be a rate cut, particularly if inflation continues to head toward its target range.

Sources: *FactSet