Why stocks could see a 10% pullback later this year

By Joseph Adinolfi

Even if stocks see a brief correction, 2024 is still shaping up to be a remarkable year for markets

Both the S&P 500 and Nasdaq Composite have seen a remarkable record-setting run so far in 2024, even as some corners of the stock market have continued to struggle. But trouble may lurk in the back half of the year.

Since the latest leg of the bull market began, the biggest hiccup investors have seen occurred in April, when the S&P 500 SPX fell by 5.5% between the close on March 28 and the close on April 19, according to FactSet data.

But history suggests a bigger pullback may be in store. According to Dow Jones data, the S&P 500 has seen 51 pullbacks of 10% or more since the beginning of 1958. This means that, on average, stocks rarely go more than a year without a correction, which is defined as a decline of 10% or more from a recent high.

Wall Street strategists responsible for predicting where stocks are heading in the coming months know this. Even some of those who recently raised their year-end targets for the S&P 500 have warned about the possibility that the market could see a bigger bout of volatility before the start of 2025.

When he rolled out his revised year-end target last month, Brian Belski, chief investment strategist at BMO, included a chart in the report showing that the S&P 500 has, on average, fallen 9.4% at some point during the second year of a bull market. He said he doubts 2024 will prove to be an exception.

"We are still skeptical that the 5.5% drawdown that occurred during [March and April] will be the worst for the S&P 500 this year," Belski said in the report.

But anxious investors can take comfort in the fact that, even if this pattern repeats, any pain for their portfolios is likely to be short-lived. As Belski pointed out, pullbacks during the second year of a bull market are typically followed by another rapid rally, with the S&P 500 rising 14.5% on average.

It's understandable why many on Wall Street are concerned that stocks might stumble. For nearly eight months, the S&P 500 and Nasdaq Composite COMP have marched relentlessly higher with hardly a misstep. Along the way, these indexes have notched 31 and 20 record closing highs, respectively, according to Dow Jones Market Data.

And it isn't just stocks that have rallied in 2024. From commodities to cryptocurrencies to the U.S. dollar, markets have generally trended higher this year. Even bonds are on the cusp of erasing their year-to-date losses as Treasury yields decline.

But this apparent calm on the surface masks the sometimes wild swings in shares of individual stocks - which have been occurring more frequently. A report from a Goldman Sachs (GS) trading desk recently showed that the average S&P 500 stock has recently been 4.5 times as volatile as the index. Nvidia Corp., one of the most valuable companies in the world, has seen its shares fluctuate wildly over the past week, erasing roughly half a trillion dollars' worth of market value over a few days.

This brings us to the next piece of historical data: Stocks are headed for their best first-half performance during an election year since 1976, Dow Jones data show.

That the market has continued to march higher in 2024 contrasts with the typical election year, according to Carson Group's Chief Market Strategist Ryan Detrick.

See: Stocks are having their best election year since 1976. What the rally needs to continue.

If the April drop ultimately proves to be the worst investors see, it would mark the smallest inter-year drop for the S&P 500 during a year where Americans headed to the polls to vote for president since 1972.

Based on Detrick's analysis of the data, there is ample precedent for a double-digit slide. Going back to 1950, the S&P 500 has on average fallen 13% from peak to trough during election years. By comparison, the S&P 500 has risen 14.7% year-to-date, while the Nasdaq Composite has gained more than 18%, FactSet data show.

Stocks have also been unusually calm on a day-to-day basis, which some - including BTIG's Jonathan Krinsky - see as a sign that the market may be overdue for another injection of volatility. As of Tuesday's close, the S&P 500 has gone 337 days since a 2% pullback, the longest since a streak of 351 trading days that ended in February 2018, Dow Jones data showed.

If the market can hold out until July 17, it would mark the most placid stretch for the S&P 500 since a 949 trading day streak that ended in February 2007, according to Bespoke Investment Group.

The stock market's "fear gauge" has also been broadcasting the all-clear, which could signal that investors are growing complacent, leaving the market more vulnerable. The Cboe Volatility Index VIX, which gauges implied volatility based on trading activity in S&P 500 options, has remained subdued after hitting a nearly five-year low last month.

To be sure, past performance is no guarantee that markets will see similar behavior in the future. And for disciplined long-term investors, a brief bout of volatility likely won't matter much anyway.

After all, history also shows that, over time, stocks mainly move in one direction: up.

-Mike DeStefano contributed reporting

-Joseph Adinolfi

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06-26-24 0916ET

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