The stock market has enjoyed major returns since the spring, with the S&P 500 and Nasdaq surging over 25% and roughly 40% since April 8, when a brutal sell-off caused oversold signals to flash.
The returns are impressive considering the historical average return for the benchmark index is about 10% annually.
Yet cracks may be forming in the rally, given lackluster economic data on inflation and jobs last week sent the S&P 500 tumbling about 3% from its early week highs through Friday.
The big question on most investors’ minds is whether it makes more sense to buy dips or sell rips (rallies) following the drop.
Veteran analyst Tom Lee, Fundstrat’s founder and head of research, correctly predicted the rally in April. Over the weekend, he offered up a blunt message for investors.
Fundstrat’s Tom Lee, who correctly predicted the stock market rally in April, updated his market outlook.Image source: Getty Images.
The S&P 500 was arguably due for a break. Before last week’s stumble, it had reached all-time highs, lifting its forward price-to-earnings ratio, a key valuation measure calculated by dividing price by earnings, to 22.4, according to FactSet.
The last time we had a P/E ratio this high was near February’s highs, shortly before the stock market fell by 19% on concerns President Trump’s tariff strategy could cause stagflation, a period of no growth and rising inflation, or worse, a recession.
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We may not see another near bear market drop this time, but inflation has climbed over the past three months and the latest unemployment data is worrisome, particularly given August isn’t known for being overly kind to investors.
Since 1950, the average post-Election year return in August is negative 1.2%. Overall, August ranks just 11th out of 12 months for S&P 500 returns, according to the Stock Trader’s Almanac.
Despite that backdrop, Tom Lee is unfazed, telling Fundstrat clients in a research note over the weekend to “buy the dip.”
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The long-time Wall Street watcher has been tracking stocks since the 1990s. Lee is best known for his bullish tilt, including accurately predicting stocks bottom in 2023 and the April low.
He thinks any August selloff following inflation and jobs data will be short-lived, and that data suggests a friendlier Fed. So far, the Fed has left interest rates unchanged this year, despite cutting them by 1% into the end of 2024.
“The economy is solid and soft enough that the Fed needs to make insurance cuts.” said Lee, before adding later in the note that Friday was “an“obvious buy the dip moment.”
Inline with Lee’s forecast, the S&P 500 rallied 1.5% on August 4 to 6329.94. That brought it just shy of the July 31 close of 6339.39 before the jobs report.
Whether sellers emerge again this week may hinge on how comfortable investors are that the economy will bend, not break, and the Fed will play ball.
The inflation data is concerning, given that the Personal Consumption Expenditures index shows it accelerated to 2.6% in June, up from 2.2% in April.
The jobs data isn’t overly encouraging either, given the latest Bureau of Labor Statistics report showed the US economy added only 73,000 jobs in July, below the 100,000 expected, and previous months were revised sharply lower.
Related: Jobs report shocker resets Fed interest rate cut bets
“Even more worrisome is that the numbers for the previous two months noted larger-than-normal revisions. The May number decreased to 19,000 from 144,000 and the June number fell to 14,000 from 147,000,” noted Fundstrat strategist Hardika Singh.
With inflation and unemployment rising, increasing the possibility of stagflation, it’s understandable that investors might get a bit antsy.
Stocks may have dropped more last week if not for growing optimism that rising unemployment means Fed Chair Jerome Powell will cut rates at the next FOMC meeting on September 17.
The latest odds from CME’s closely watched FedWatch tool place probabilities of a quarter-percent cut to a range of 4% to 4.25% at about 94%, up from 64% one month ago.
An interest rate cut would be good news for stocks, given lower lending rates encourages household and business spending, supporting revenue and profit growth at publicly held companies.
That potential may trump any short-term economic concerns.
“For now, I see further downside as being short-lived and largely contained,” concluded Fundstrat’s technical analyst, Mark Newton.
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