History Says Stocks Will Rally In The Second Half

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Stocks made little noise during a holiday-shortened session on Monday.

Investors will return for a full trading day Wednesday with a focus still firmly on how the second half of 2023 will unfold.

And folks would be forgiven for expecting some bearish mean reversion in the months ahead. But after slicing and dicing the outsized returns from the first and second quarters, our work shows the tape clearly showing history is with the bulls.

Looking back over the prior 95 years of history for the S&P 500 (^GSPC), in 61 years returns in the first half were positive.

In 28 years — or nearly half the time — the index posted double-digit percentage gains, including this year which saw the index rise 16% to start the year. And in these years, the second half returned, on average, 6% with a win rate of 75% and an average Sharpe ratio of 0.87. The median return after these years was a more robust 9.7%.

S&P 500 Returns After 10% Surge in First Half of Year
S&P 500 Returns After 10% Surge in First Half of Year

Looking only at the first six-month returns following a year of negative results — which includes this year — improves the odds.

In those ten years, the average second-half return was 9.8%, the median return 11.5%, the win rate at 80%, and an enviable average Sharpe ratio of 1.82. Of course, this does suggest that mean reversion is alive and well, but on an annual rather than semi-annual timeframe.

The nuanced results for the S&P 500 presented here are a bit different than those we found for the Nasdaq Composite (^IXIC), which appears to have an aversion to results that are simply “too good.”

With the S&P 500, we didn't find significant edges to be found by filtering for the total number of positive days or total days above the 10-day moving average.

Nevertheless, the bottom line for investors is that the strength we've seen so far this year tends to beget more strength. At least when it comes to the S&P 500.

Seasonal tailwinds can account for up to a third of an instrument's returns, meaning the ultimate direction for major indices are still overwhelmingly based on the fundamentals du jour.

Accordingly, we'll still be tracking the Fed's favorite economic reports and second-quarter earnings this month with bated breath.

But those who ignore history, in markets or otherwise, do so at their own peril.