S&P 500 finally suffers a big drop – what comes next?
S&P 500 finally snaps its winning streak
Until yesterday, the S&P 500 had gone 356 trading days without a 2% drop. This is the strongest run since 2017 for the index, and underscores how powerful this rally has been.
Winning streak chart
What happened on Wednesday?
The NASDAQ 100 and S&P 500 have experienced their sharpest single-day decline since 2022, primarily driven by disappointing financial results from Tesla and Alphabet.
This sell-off highlights broader concerns about the high valuations of the "magnificent seven" (Mag7) tech giants - Microsoft, Amazon, Alphabet, Tesla, Meta, NVIDIA, and Apple - and their outsized influence on the wider US market. NVIDIA, a major beneficiary of the AI boom, was particularly affected due to worries about US-China-Taiwan trade tensions. The tech sector is under increasing pressure to demonstrate returns on their substantial AI investments, with investors growing impatient to see profits materialize from these massive expenditures.
This market reaction reflects a potential turning point in the AI rally, where the sustainability of tech giants' growth is being questioned. Some analysts are advising investors to diversify their portfolios beyond these dominant tech stocks, suggesting a possible sector rotation if Federal Reserve (Fed) interest rate cuts materialize.
The interconnected nature of these companies' performance adds to the market's vulnerability. As Meta, Amazon, and Apple prepare to report earnings next week, all eyes will be on them to provide reassurance to investors.
Is it likely to fall further?
US stocks have had a very strong run so far this year. As the below chart shows, the index has done very well, far better than an ‘average’ US election year. Thus it could see further losses from here, at least in the short-term, particularly if we get more disappointing earnings from tech stocks.
What the red line in the chart shows is an ‘average’ US election year. Normally, the market weakens in the second half of July but then rallies into August, before consolidating into September. It then falls steadily through September and October, bottoming out in the last week or so of that month. From there it begins a rally into the end of the year.
US seasonality chart
It is important to remember that the red line is the average of all US election years since 1949. It is a useful guide, but is not a firm prediction. However, US markets often weaken in September and October anyway, so an August recovery followed by a fresh decline would not be entirely unexpected.
Could it recover from here?
Much depends now on the performance of Big Tech earnings next week. Should these fail to meet forecasts, or issue gloomier outlooks for the month ahead, then stock markets generally could fall further.
Since NVIDIA's peak on 20 June, the stock has dropped 17%, while Meta is down 8%. Tesla remains up over the past five weeks, though it has dropped back in the wake of earnings.
Mag7 performance
S&P 500 – technical analysis
The falls of the past two weeks is the biggest move lower for the S&P 500 since April, when it bottomed out around 4920.
In the short-term, more losses are likely to target the 100-day simple moving average (SMA), currently 5300. Below this lies the late May low at 5191.
It is important to remember that corrections happen in even the strongest bull markets, and are a necessary part of life. By the July peak, the S&P 500 had rallied almost 15% from its May low, and was up 38% from the October 2023 low. A correction was bound to happen at some point.
For the moment however, the uptrend is still firmly intact.