The S&P 500’s Rally Has Stalled. Why July Will Be Critical.

It could be a cruel summer for the S&P 500.

The index’s rally stalled this month—and it could break down after several key events unfold in July.

The S&P 500 rallied 33% from a key low point in late October to a record close of 5,487 points on June 18. Big Tech stocks weren’t the only ones driving the surge; the other 10 S&P 500 sectors played a part, too. However, the S&P 500 has dropped 0.5% to 5,460 since reaching the new high. Investors have been eager to take profits by selling.

That dynamic played out in full this week, with good news failing to spark a rally. On Friday, the Bureau of Economic Analysis released the May reading of the personal consumption expenditures index, the Federal Reserve’s preferred measure of inflation. The data showed a 2.6% year-over-year increase, down from April’s 2.7%. The Fed’s inflation target is 2%, so it’s still possible that the central bank will cut interest rates later this year to keep the economy growing. The S&P 500, however, finished the day in the red, because it had already anticipated for months that the data that would support near-term rate cuts.

This type of optimism has made stocks expensive, driving buyers away from the market in the last few trading sessions. At 21 times expected earnings for the coming 12 months, the S&P 500’s price/earnings multiple has been at the high end of its range since early 2022, when the Fed began lifting interest rates. Higher rates reduce, rather than increase, the value of companies’ future profits.

Pricey valuations mean that to keep the rally going, the market needs confirmation that rates are dropping—and earnings are increasing.

July will be critical. Wall Street is waiting for the June reading of the consumer price index, which is due out on July 11. Consensus estimates from economists surveyed by FactSet call for a 3.1% year-over-year increase, which would be down from May’s 3.3% result. That would help validate the market’s thesis that the Fed could cut rates soon.

The Fed’s policymaking committee will also hold its monthly meeting July 30-31, which central bank officials will conclude by announcing their latest interest rate decision. Markets expect the Fed to keep federal-funds rate unchanged at a range between 5.25% and 5.5%, but they will pay particular attention to any indication from the bank about coming interest rate decisions.

Fed Chairman Jerome Powell is slated to deliver remarks at a July 31 postmeeting press conference—and two general scenarios could play out. If Powell hints that the Fed would like to slash rates soon, he would do so by emphasizing that interest rate policy is dependent on incoming economic data—and stocks could break out and reach new highs. If he comes across as “hawkish,” or more likely to keep rates at current levels for an extended period, stocks may have nowhere to go but lower.

“The unending wait for a Fed rate cut is entirely capable of extending through the summer,” writes Walter Zimmerman, chief technical strategist at ICAP Technical Analysis.

That puts certain S&P 500 levels into focus. Should the index fail to break above its current record, that could signal more declines for some time.

If the S&P 500 drops on the back of negative economic developments, pay attention to the 5200-to-5300 range: this spring, buyers came in at these levels to send the index higher. If they support the S&P 500 at these levels once more, their backing indicates that traders are confident in the market’s outlook—and are ready to bid it higher. If investors don’t show up, it means such conviction has dried up and more declines are likely on the way, Zimmerman notes.

The index’s 50-day moving average, currently at 5,269, is also important: the S&P 500 has usually seen support at that average over the long-term, according to FactSet, but when it dips below, it often sees further declines. In the past three years, there have been several instances in which the index dropped beneath the average and continued to fall before bottoming out—with three of those occasions featuring double-digit drawdowns.

Stocks are about to heat up or cool down this summer, but the events in the coming weeks will be the deciding factor.

Write to Jacob Sonenshine at [email protected]