Market Extra: After a strong July, August looks ominous for stocks

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The month of July has lived up to its historical reputation for strength, and should the U.S. stock market continue following long-term seasonal patterns, investors should feel cautious going into August.

According to the Stock Trader’s Almanac, August ranks as one of the weakest months of the year for major indexes, with steeper losses in midterm years, as the current one is.

The Dow Jones Industrial Average DJIA, +0.07%  has historically fallen 0.2% over the month of August, according to data that goes back to 1950, making it just the 10th best month of the year. Over the past 67 years, August has been positive for the blue-chip average 37 times, and negative 30 times.

For the S&P 500 SPX, -0.19% July is the second-worst month of the year. The benchmark index typically dips 0.1% over the course of the month, according to the Almanac; of the past 67 years, 36 have featured a positive August for the S&P 500.

August also comes in as the 11th best month of the year for the Nasdaq Composite Index COMP, -0.85% although the tech-heavy index has historically managed to eke out slight gains, rising 0.1% over the month, on average. Over the past 45 years, the Nasdaq has seen 25 positive Augusts and 21 negative ones.

The picture turns decisively more negative in years in which there are midterm elections, however. In such Augusts, the Nasdaq typically falls 1.8%, a far steeper decline than is seen in the other benchmarks. The Dow typically falls 0.7% in midterm Augusts (compared with a 0.2% drop otherwise) while the S&P is down 0.4% (compared with a negative 0.1% move). Of course, the slightness of such moves means that should indexes match their long-term average August performance, it wouldn’t appreciably change Wall Street’s narrative about stocks, which continue to weigh strong earnings growth against the prospect of escalating trade tensions between the U.S. and its major trading partners.

The Nasdaq has been the top-performing index of the three main gauges in 2018. It is up 12.1% thus far this year, compared with the 5.4% rise of the S&P. The Dow is up 3% in 2018. The Nasdaq’s outperformance has come as large-capitalization technology and internet names have continued their march higher in 2018, while the weaker gains of the Dow have been attributed to the prospect of a trade war, a headline risk that the Dow—which is more heavily weighted toward multinational stocks—is more exposed to.

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Another outperforming index in 2018 has been the Russell 2000 index RUT, -0.07%  of small-capitalization shares, which is up 8.3% thus far this year. The Russell is seen as insulated from the trade issue due to the higher domestic revenue exposure of its components.

Historically, the Russell rises 0.2% over the month of August, which makes for its ninth-best month of the year. In midterm years, however, the Russell slumps 1.9%.

Summer months are sometimes seen as risky for Wall Street, due to a historical trend embodied by the phrase “sell in May and go away.” What this means is that the stretch between the start of May and the end of October has been a seasonally weak period for markets. While this has been true over the long term, as seen in the following table that looks at S&P 500 performance, the trend hasn’t held over the past five years, according to the WSJ Market Data Group.

Courtesy WSJ Market Data Group

Thus far in July, the Dow is up 4.9%, the Nasdaq is up 3%, and the S&P gained 3.7%, a rally that ended the benchmark index’s longest correction since 1984. The Russell has gained 1.2%. All four have outperformed their historical moves in the month.

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