2 Good Reasons the Stock Market Isn't Ready to Blow Up Yet - Barron's

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The rally is broad-based and trading volume is up.

NYSE

Stocks have had an impressive year so far, but there are still four months before 2021 wraps up. So what’s ahead? A correction? More gains? Right now, it’s easier to make the case for the rally to just keep on going.

First, though, it’s understandable why investors might be nervous.

The S&P 500 has gained about 21% year to date, far above the historical average annual return of about 10%. And in the first eight months, the index hasn’t had a pullback of more than 5%— a correction is defined as a 10% drawdown.

Still, a good run needs something to stop it—like higher corporate taxes, which the Biden administration supports. They could shave 5% or more off projected earnings estimates for S&P 500 companies. Or persistent inflation, which could cause the Federal Reserve to rapidly reduce economic support. And there are a host of other catalysts, enough to push some analysts to forecast a retreat. 

But who knows how long Washington might take to put a new tax structure in place, or if lawmakers even will. Or what the deal is with inflation. There has been tapering talk for a few months now, and the Fed holds firm to its wait-and-see approach.

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So the nature of the market’s climb in the past couple of weeks seems to be the surest, strongest sign of what’s ahead. The S&P 500 is up 3% since Aug. 18, the bottom of a brief and shallow drop.

“[Market] internals improved last week,” writes Michael Gibbs, director of equity portfolio and technical strategy at Raymond James. 

First off, transaction volumes are improving.

In late August, the daily number of shares traded on the  SPDR S&P 500 Exchange-Traded Fund Trust (SPY) has been about 54 million, according to FactSet. That’s above just under 50 million seen in the middle of the month.

The upshot: When more market participants are transacting and they are bidding prices higher, it’s a vote of confidence in the market. 

Secondly, the rally has been broad-based—many stocks have participated. For example, almost 80% of stocks listed on the New York Stock Exchange have been gaining, according to Raymond James.

The last time that metric hit such a high was November 2020. More stocks participating in the rally means the major indexes are less dependent on one group of stocks to move higher. Plus, with economically sensitive stocks on a run as well, it means investors are confident in sustained economic growth ahead. 

So more gains or a correction? We’ve made our case, but time will tell.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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