As August Ends, S&P 500 Riding High On Spring-Summer Rally, But Can It Continue?

The broad-based S&P 500 stock index is poised to deliver its best August performance in almost 35 years as the rally that began in late March continues headlong.

Through Friday, the S&P 500 has gained 7.24% in August -- the highest monthly showing for that month since 1986.

August’s strong performance comes on the heels of a spring-summer rally for the index – it surged 12.7% in April, gained 4.5% in May, edged up 1.8% in June, then jumped 5.5% in July. All of these gains have take place amid the unprecedented calamity of a global pandemic, the shutdown on untold hundreds of thousands of businesses and high unemployment.

Indeed, from the lows of late March, the S&P 500 has surged 56.79%.

Investor confidence has also been boosted by the anticipated arrival of a vaccine for COVID-19 by late 2020 or early 2021.

“August is going to come out looking like capital markets are endorsing a U.S. cyclical recovery,” Nicholas Colas, co-founder of DataTrek Research, said in a note.

However, Colas pointed out that the S&P 500’s August rise was largely driven by a 17.67% monthly surge by tech behemoth Apple (AAPL). In fact, since March lows, Apple shares – the largest component of the index by far -- have skyrocketed 123.5%.

Excluding Apple, the S&P 500 would be up about 4% in August.

“This [outperformance by Apple] meaningfully skews everything from tech sector returns to growth/value performance spreads and even the S&P 500′ s August return,” Colas said.

Some analysts worry that the rally has been pumped up artificially by massive federal stimulus and a few high-flying tech stocks, but James Paulsen, chief investment strategist of The Leuthold Group, is bullish on the market.

“People think there is no legitimacy to the rally, and they’re wrong,” Paulsen said. “Look at retail sales, or the [Institute for Supply Management data], or housing, or auto sales. Look at the improvement in unemployment claims. They’re all bouncing.”

Paulsen is highly optimistic about the U.S. economy’s near-term prospects.

“We may have an 18% improvement in [gross domestic product] in the next 12 months, and that also would be an all-time high,” he said. “That is going to bring in the broader market along with it. You are going to have a major league shift in profitability into those cyclical names.”

David I. Kass, clinical professor of finance at the University of Maryland in College Park, Maryland, told International Business Times that the primary factor behind the rally has been the federal stimulus packages.

“The Federal Reserve [has expanded] its balance sheet along with parallel actions taken by Congress and the Treasury,” he said.

This rebound, he noted, has been led by the five largest tech stocks – Apple, Amazon (AMZN), Microsoft (MSFT), Google-parent Alphabet (GOOG), and Facebook (FB). Together, they represent 25% of S&P 500 total market capitalization.

“The tech stocks have led this rally as they have both benefited from the current pandemic-induced stay at home economy, are projected to have strong growth in the years ahead, and have balance sheets with very little debt,” Kass explained.

"Since fixed [income] assets, like short-and long-term bonds, offer negligible yields, stock market investments are an attractive alternative," said Kass.

“Since stock prices reflect expectations about the future, investors expect the economy to grow substantially during the rest of the year and continue growing next year,” James R. Barth, the Lowder eminent scholar in finance at Auburn University, told IBT. “The rapid movement to online shopping due to COVID-19 has led to far greater increases in the stock prices of more technology-oriented companies.”

Hernando Gomez, a principal at accounting firm MBAF, told IBT that it took the S&P 500 index only 130 trading days to recover from the bear market between February and March.

To put things in perspective, Gomez added, a typical peak-to-peak recovery takes an average of about 1,500 trading days, so the current speed of the market recovery might signal other variables playing along.

“The digital transformation has been expedited in great part due to the pandemic,” he added. “As demand shifts continue to be more evident, the tech segment may continue leading the growth.”

But Steve H. Hanke, a professor of applied economics at Johns Hopkins University, who served on President Ronald Reagan's Council of Economic Advisers, told IBT that the real fuel behind this year’s stock rally has been the collapse in the real interest rate.

“The 10-year Treasury Inflation Protected Securities, TIPS, are now yielding a stunning minus-1%,” he said. “This has lifted all [stock price] multiples across the board. After all, a multiple of 40 generates an earnings yield of 2.5%, and even a multiple of 50 still generates an earnings yield of 2% – both well above minus-1%. As long as real yields stay in negative territory, multiples will remain elevated.”

TIPS are Treasury bonds that are indexed to an inflationary gauge designed to protect investors from the decline in their money’s purchasing power.

As for the near-term outlook, Kass noted that since Fed Chairman Jerome Powell announced a policy change Thursday, which is likely to lead to near-zero interest rates indefinitely, that “the stock market rally is likely to continue through the rest of the year.”

Kass also noted that if there is a Democrat sweep in the White House and Congress, then “there will very likely be a second, more generous, stimulus package. This should boost the economy and stock market.”

Whether the stock market rally will continue will certainly depend on the outcome of the presidential election, Barth said.

“Who becomes president will determine the policies that will be implemented over the next four years and the two nominees have quite different policies in mind,” he said.