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Why the S&P 500 could be poised for a 5% drop — or even more this summer

The S&P 500 may be due for a pullback

MarketWatch photo illustration/iStockphoto

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Monday’s market rout could serve as a good reminder that, yes, stocks can stumble when they trade near record territory.

While the downward pressure on stocks, this time, has been fleeting, that doesn’t necessarily mean the end of volatility for markets this summer, said Ryan Detrick, chief market strategist at LPL Financial, in a Wednesday note.

“From less stocks participating, to weak seasonality, to a lack of bears, to typical choppiness during year two of a bull market, the summer months could be ripe for an eventual pullback (down 5-9%) or even a 10% correction,” Detrick wrote.

Those were among the “many reasons” why after a more than 90% rally, he thinks the S&P 500 index SPX, +1.01% “could finally be ready for a break,” particularly when it comes to the often difficult months of August and September.

This chart shows average monthly returns for the S&P 500 in August and September, since 1950, have been largely negative, when looking over different stretches of time.

August and September often are trouble for stocks

LPL Financial

The study includes the modern S&P 500 index, launched in 1957, but also performance of the S&P 90, its predecessor index.

Historically, the chart also shows that April, July and November tend to be the best months for S&P 500 returns.

But despite a bruising Monday, the S&P 500 was up 0.7% on the week through Wednesday, while the Dow Jones Industrial Average DJIA, +0.68% was 0.3% higher for the same stretch, as investors snapped up beaten down shares in the energy XLE, -0.37% and financial XLF, +0.17% sectors.

Read: What junk bonds are signaling for this summer after Monday’s sharp rout

“Incredibly, we haven’t seen as much as a 5% pullback since October,” Detrick said, while pointing out the average year since 1950 has recorded three separate S&P 500 retreats of 5% or more, “with not a single one happening yet in 2021.”

“This doesn’t mean a 5% correction is directly around the corner, but note that most stocks are actually already down as much as 10% off their recent highs, suggesting the internals of the market are a tad weak and risk is higher than normal.”

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