The Tell: Will August stock-market stumble turn into a rout? Here’s what to watch, says Fundstrat’s Tom Lee

An August pullback in the 2023 U.S. stock-market rally hasn’t exactly come as a big surprise, with even some of Wall Street’s biggest bulls having argued there was scope for some consolidation.

August tends to be a rocky month, with volatility often hitting its peak for the year. You can also throw in often low volume trading conditions, particularly in the latter half of the month, as vacation season sees its end-of-summer last hurrah.

But the 5.6% slide for the S&P 500
over 15 trading sessions through Thursday is about as bad as August typically gets, noted Fundstrat’s Tom Lee, in a Friday morning note. Still, Lee, one of Wall Street’s bulls, maintains that the pullback will likely prove to be an “it’s August” phenomenon.

“We see stocks selling off for known and logical reasons,” he said.

Those reasons include the 50 basis point rise in the 10-year Treasury yield, pushing the rate to a 15-year high this week, a rising U.S. dollar and a long-awaited jump in the Cboe Volatility Index.

Earlier: A stumbling stock market faces a crucial summer test. Here’s what will decide the bull’s fate.

The S&P 500 index and Nasdaq Composite
on Friday were headed for a third straight weekly loss, while the Dow Jones Industrial Average
was headed for a 2.2% weekly decline.

So what would it take to turn the slide into a serious rout, which Lee defined as a 10% pullback to the 4,150 level for the S&P 500?

The rise in yields “would need to threaten to ‘break something’ or there would need to be an additional exogenous shock,” Lee said.

“I am not saying that cannot happen. For instance, if oil surges another 10% and signs of wage pressures rise, then this could turn into a larger selloff. Why? Because it would make investors question whether inflation is on a glide path lower,” Lee wrote.

See: Why Treasury yields keep rising, causing pain for stock-market investors

For now, the inflation story is taking a back seat, Lee said, investors focusing on rising bond yields which weigh on price-to-earnings ratios, and signs of a strengthening U.S. economy which raises the risk of more Federal Reserve interest rate increases. China’s weak economic data and property woes are also a concern, at least at the margin, for U.S. investors, he said.

Need to Know: Bond yields hold the key to an emotional market that can change on a dime, says this strategist

But Lee argued that the market is offering signs that stability may soon return.

For one, while the speed of the surge in the 10-year yield is hurting stocks, such jumps often occur near the end of a selling cycle for equites, he said. He noted that the 50 basis point, or half a percentage point, jump in the Treasury 10-year yield seen over 21 days echoes yield jumps that ended on Sept. 23 and March 2 of last year. In those instances stocks bottomed 8 to 16 days later.

Second, stocks are technically oversold, with a gauge known as the McClellan Oscillator dropping to -50. That’s happened just 39 times since 1990 and 51% of the time, stocks bottomed within five days, and 72% of the time bottomed within 15 days, Lee said.

With that time frame in mind, Lee offered a couple of dates that could prove important for the markets next move, including Aug. 24, the morning after chip maker Nvidia Corp.

reports fiscal second-quarter results. Nvidia’s blowout results this spring were credited with sparking an AI frenzy that saw megacap tech stocks surge ahead.

Investors will also be paying attention on Friday, Aug. 25, when Federal Reserve Chair Jerome Powell is scheduled to address the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming.

Last year, Powell’s Jackson Hole speech marked the top of a bounce for the S&P 500, with stocks then falling 19% over the next eight weeks, Lee recalled.

“Could stocks rally 20% after this year’s Jackson Hole? I don’t think so, but anything can happen,” he wrote.