August is typically a rough month for stocks and could be again

What’s the setup for August? Likely more volatile than July.

Fed Chairman Jerome Powell threw a modest curve ball at the market Wednesday when he did not automatically endorse additional interest rate cuts. If there is one thing that has made it easier for the bulls to stay bullish, it is the direction of rates.

The markets are becoming more dependent on the belief that dovish central banks will provide a backstop to slower global growth — and it’s true that lower rates do help.

The markets were tilted to an extremely dovish outcome and Powell struggled to deliver that outcome. The markets bear some of the blame: Nothing in the U.S. economic data or comments from Fed officials of late provided strong support for a continuing rate-cut narrative. As UBS said after the meeting, “the data won.”

Still, there is no shortage of bulls on Wall Street. The positives:

1. U.S. economic data remain strong for the most part.
2. Interest rates are low.
3. There’s still an assumption that central banks will continue to lower rates, even if Powell did not provide strong support.

The negatives:

1. Stocks are pricey because the S&P 500 is up 20% in 2019 and earnings are essentially flat, so the risk is very much to the downside.
2. Clarity on global growth, including tariffs and trade, is still very elusive.
3. History is not on the side of markets in August. It’s the worst month for the Dow and S&P since 1987, according to the Stock Trader’s Almanac. Looking at its full history, the average August move for the Dow is a slight decline.

Despite all the uncertainty, many traders believe that the market will continue to find new leadership.

“I think the market will continue to have a very vibrant rotation,” said Tim Anderson, managing director at TJM Investments. He noted that four Dow components — 3M, Caterpillar, Boeing and UnitedHealth — had together been responsible for lowering the Dow Jones Industrial Average by nearly 1,500 points in the last several months as these stocks are well off their recent 52-week highs — yet the Dow is just shy of historic highs.

“The market continues to rotate where there is value and some reasonable growth opportunities,” he said. “Recently, that has included Microsoft, McDonald’s and Coke.”

Weak earnings growth — likely to be 3% this year, according to Goldman Sachs — is not worrying investors much because it is coming a year after a 23% bump from the tax plan, he said.

As for the Fed, many believe Powell will ultimately deliver additional rate cuts.

“If we need another cut, Powell will give us one,” said Alec Young, managing director of global markets research at FTSE Russell. “It’s the bond futures guys that messed up. There’s a lot of groupthink among traders.”

Still, the perceived benefits from the Fed cutting rates seems to have passed. And that could be a problem for stocks in August.