Friday, July 7, 2023
Key Takeaways:
- The second half is off to a relatively slow start as the S&P 500 battles overbought conditions and a backup in interest rates.
- Economic resiliency and a tight labor market have kept Federal Reserve (Fed) rate hikes on the table, along with hopes for a soft landing scenario.
- Correlation analysis comparing the first half of prior years to 2023 suggests history is on the market’s side. Of the 10 highest correlated first halves to 2023 (since 1950), the S&P 500 generated average and median gains of around 12% in the second half, with nine out of 10 periods producing positive returns.
- The year 1995 stands out with a high correlation to 2023 and a relatively similar macro backdrop to now. During the first half of 1995, also a pre-election year, the Fed paused an aggressive rate hiking cycle after tackling higher inflation and avoided a recession. The soft landing helped drive the S&P 500 up 13.1% in the second half.
- Of course, this observational data comes with the major asterisk of correlation does not imply causation. And while history may not repeat, it often rhymes, which would be a welcomed sign for the second half.
Correlation Comparisons
As noted in our Second Half Setup blog last week, the S&P 500 had an impressive first half price gain of 15.9%. Given the mostly one-way direction of price action this year, including the S&P 500’s tenth-best first half in 73 years, we analyzed first half correlation data to find years that closely resemble 2023. More specifically, we calculated the daily return progression of the S&P 500 for every year going back to 1950 and ran a correlation analysis comparing the first half of each year to the first half of 2023. The bar chart below shows each year’s first half correlation to 2023.
As you may notice in the chart above, a limited number of years have a high correlation to 2023—not a major surprise considering the average first half price return for the S&P 500 is 4.0% over this time frame. The table below provides a deeper breakdown of the top 10 highest correlated years, including how the market performed during the second half and the entire year.
To provide historical context beyond correlation coefficients, we included some additional macro insights for each year above. A few key highlights:
- In terms of the closest analog to 2023, 1958 has the highest correlation coefficient and a comparable first half return to 2023. However, the macro environment was much different then, as the first half of 1958 overlapped with a recession and a downward trajectory of the fed funds rate.
- The year 1995 stands out with a high correlation to 2023 and a relatively similar macro backdrop to now. During the first half of 1995, also a pre-election year, the Fed paused an aggressive rate hiking cycle after tackling higher inflation and avoided a recession. The soft landing helped drive the S&P 500 up 13.1% in the second half.
- Of the 10 highest correlated first halves to 2023, the S&P 500 generated average and median gains of around 12% in the second half, with nine of 10 periods producing positive returns.
Given the relatively high correlation between the first half of 1995 and 2023, and the similar macro backdrop between now vs. then, we used the second half return progression of 1995 to forecast the return progression of the S&P 500 for the remainder of 2023. The chart below highlights the S&P 500 during 1995 and the actual first half of 2023, along with the forecasted price progression of the index into year end. Under this scenario, the S&P 500 would finish the year at 5,032 (+13.1% from the June 30 close). As you will see on July 11 with the release of LPL’s Midyear Outlook 2023, we are calling for more modest second half gains, but this analysis illustrates a larger potential opportunity in the event of a soft landing for the U.S. economy.
SUMMARY
Stocks have struggled out of the second half gate after facing headwinds from a backup in interest rates and overbought conditions. Correlation analysis comparing the first half of prior years to 2023 suggests history is on the market’s side. Of the 10 highest correlated first halves to 2023 (since 1950), the S&P 500 generated average and median gains of around 12% in the second half. One of those years is 1995, which was also a pre-election year with a similar macro backdrop to today. While the 13.1% second half gain in 1995 may be a little too optimistic for 2023, the analog at least provides some framework for the potential size and scope of a second half advance if the economy avoids a recession.
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