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How September could look slippery for stocks, strategist explains

The S&P 500 may be on track to show its worst monthly performance in August since December 2022. CFRA Research Chief Investment Strategist Sam Stovall joins Yahoo Finance Live to discuss market outlooks for the remainder of 2023.

"With the uncertainty leading up to the September 20 FOMC meeting, that could offer enough concern, uncertainty that would allow the markets to tread water," Stovall says, forecasting this week's PCE data to be a "negative surprise" for year-over-year headline and core inflation prints.

Stovall also comments on small and mid-cap stock valuations as compared to large-cap companies, and how pre-election trends could weigh on stocks in 2023.

Video Transcript

- August is performing as expected, killing the summer stock rally and delivering a lousy month for markets. The S&P 500 has sunk more than 3% so far on track to post its worst monthly performance since December. So, should investors expect the same treatment from September? Our next guest says we should prepare for some disappointment.

Joining me now is Sam Stovall, CFRA Research Chief Investment Strategist. Good to have you back on the show. So as we're looking at August performance and then looking ahead to September, is September saying hold my beer, still more damage to come?

SAM STOVALL: Hello, Rachelle. Well, that's the question that everyone wants to hear. I think Jared did a great job of explaining what might happen based on historical precedent, especially with a strong market leading up to the August time frame. And I think there's an old saying that you can correct in both time and price.

And at the end of July of this year, the NASDAQ was 26% above its 200-day moving average. Even General Patton never got that far ahead of his supply line. So I think we need to either decline or we need to pause in order to let the moving averages work their way back up toward the indexes. And that's what's happening right now. So I believe that with the uncertainty leading up to the September 20 FOMC meeting, that could offer enough concern, uncertainty that would allow the markets to tread water.

- Would an extended pause mean possibility or potential for inflation to once again rear its head, Sam?

SAM STOVALL: Hey, Brad. Well, I think when we get the PCE numbers later this week, we might end up with a little bit of a negative surprise. Both the year-over-year headline read, as well as the year-on-year core read is expected to show a backup and actually see a slight increase in the year-over-year readings. And so investors might not take that too kindly especially in a very low-volume week as we have pre-Labor Day.

So I still think that volatility is likely to be elevated. And it's going to only get worse in October. It's 35% higher in October than the average for the other 11 months of the year.

- And so, Sam, as we look at the mid and small cap indices and how they fared, do they still have much further to fall from this point?

SAM STOVALL: Well, they've certainly fallen a long way. And when you look at the valuations, whether it's on ln absolute PE or a relative PE, the small and mid-cap stocks are trading at more than 30% discounts to their average since 2005 versus the S&P 500. So they're looking very attractive.

However, at this time of a bull market, small and mid-cap stocks should be exceeding that of the large-cap brethren. I think one reason that that's not happening is that the large-cap tech exposure at 28% is more than twice the exposure that you see in the S&P small cap 600. So as a result, with the Magnificent Seven really leading the charge, it's leaving the small-cap stocks in the dust.

- When we continue to talk about the low volume that typically is at play in the last couple of weeks in August and as we get close to the Labor Day holiday trading desks, a lot of investors they're trying to make sure that they are using that vacation time. So low volume in this period. After that period, though, do you assume that into the fourth quarter of this year we're expecting to see any type of outstanding move or conviction move in one direction or another?

SAM STOVALL: Well, I'm sort of an optimist at heart. When life gives me lemons, I make whiskey sours. And so I'm a big believer in the Santa Claus rally, the fourth quarter especially of the pre-election year. And as Jared also had mentioned about election years, looking at the election year of first term presidents going back to World War II, every one of them has been positive, not a guarantee but certainly an indication that there could be some optimism associated with that.

- So, Sam, where do you see the opportunities in this sort of environment?

SAM STOVALL: Well, I think that right now it's those groups that were leading the charge-- technology, communication services, consumer discretionary-- that had the greatest gains and therefore the greatest profits to be taken during this market pullback. And right now, all sectors, benchmarks sizes, styles are below their 50-day moving average. And as of Friday, we were looking at 9 of 11 sectors that were also below their 200-day moving averages. But I think once we get out of this seasonally-choppy period and move into a Santa Claus rally and into the election year, I would tend to go back to growth.

- Sam, why don't you line up two of those whiskey sours there. I'll have the other one. Appreciate the time here today. Sam Stovall, CFRA Chief Research-- CFRA Research Chief Investment Strategist, there we go. Sam, good to see you.

- Thank you, Brad.