The stock market this year has taken an extraordinary route toward a pretty routine destination.

The first half of 2018 has gone from giddy to gut-churning to grinding. The first three weeks of January saw the best start to a year in 31 years, with the S&P 500 up more than 7 percent. The rally immediately gave way to the fastest 10 percent plunge from a record high in 90 years.

Since then, it’s been nearly five months of choppy, labored recovery, representing one of the longer periods of consolidation following a correction in recent years. The broad market has been stopped short of its March high, set on the initial rebound from the February drop, and the S&P remains some 4 percent below the January peak.

And yet the S&P is approaching the midpoint of 2018 with a 3 percent year-to-date gain, which dividends bump up toward 4 percent — making for an annualized total return of 9 to 10 percent. That’s just about the long-term annual average return for equities over the very long term.

The market is behaving in a fairly typical manner in other ways, too. Very strong corporate-earnings growth near 20 percent has not nearly been fully reflected in share prices, which of course means the market’s price-to-earnings ratio has dropped. This “valuation compression” tends to be the rule as the Federal Reserve is on a rate-raising campaign later as the economic cycle matures.

This chart from Goldman Sachs shows how the market P/E has been suppressed since January as monetary policy slowly tightens.

This push-pull among excellent corporate results, sturdy credit conditions and no signs of imminent recession on the positive side, plus high valuations, rising rates and percolating inflation on the negative side explain the restrained but still positive market performance to date.

The history of years that managed even narrow gains by this date is pretty encouraging, as it happens. LPL Financial points out that since 1950, there have been 35 years when the S&P 500 was up at least 3 percent as of the start of summer (June 21). The remainder of those 35 years saw further gains 30 times, and only in 1987 was the loss through December more than 3 percent.

The full history is here:

Source: LPL Financial

One quirk of market behavior is that an individual calendar year index return rarely falls within the range of the long-term average annualized return — say, 7 to 11 percent. In fact, only five years out of the last 90 have seen a January-to-December return in that 7 to 11 percent range — with gains of 20 percent-plus or outright declines far more common.

So just because the first half of the year is on pace for that “normal” annual return, it doesn’t indicate the coming months will play out in such a neat-and-tidy way.

At this point, the weight of the evidence still suggests further upside progress, based on the underlying trend and supportive corporate fundamentals. But it remains an uneven, selective market in several ways.

The dominance of growth stocks — mostly technology and the e-commerce giants in the consumer discretionary sector — has become quite pronounced.

Bespoke Investment Group points out that 15 S&P industry groups have outperformed the overall S&P 500 by at least 10 percentage points this year (mostly tech, retail and transportation), while 22 groups have lagged by at least that much (a mix of industrials, consumer staples, telecom and airlines)

The outperformance of the U.S. indexes versus the rest of the world has also grown stark, as the Fed’s tightening, the dollar’s rise and trade confrontations take their toll on foreign markets.

Yet the advance this year has been broad enough to keep the running daily tally of rising-minus-declining stocks near a record high. And the Dow is in its longest streak trading above its 200-day average (some 500 days) since 1987, meaning the long-term trend has stayed positive.

So the market is not fully “in gear,” and has stalled out more frequently in recent months, but it continues to move in the right direction — in a mostly “normal” way — for now.





