​​Is a stock market summer correction due?

​​​Is a stock market summer correction due?

​European stock indices have taken a beating in the first few weeks of June when compared to Asian and US indices, trading in one-month and all-time highs respectively.

​The question on investors’ minds is whether the European sell-off might spread to global indices during the historically less favourable period of the year for equities between May and October.

​European election result and French snap election create uncertainty

​The shift to the far right in the European elections and France’s snap legislative election wiped around E240 billion off the French stock market and led to an over 5% drop in its value in a single week, the worst weekly loss since 2022. The CAC 40 thereby erased all of its year-to-date gains after hitting record highs only a month ago.

​European versus US stock indices one-month comparison chart

​The French government’s borrowing costs soared as a result of bonds suffering sharp sell-offs as French interest rates on 10-year debt rallied to levels on par with Portugal for the first time in two decades.

​The London Stock Exchange (LSE) benefitted from the French stock market debacle and regained its crown, lost 18-months ago, as Europe’s largest stock exchange. Nonetheless the FTSE 100 and FTSE 250 were not immune from last week’s global asset re-allocation out of European stocks into emerging market and US mega caps with the likes of Nvidia overtaking Microsoft as the world’s most valuable company.

​Can the rout in European stock indices drag US markets lower?

​So far the S&P 500 and Nasdaq 100 have continued to make record highs, almost on a daily basis, and benefitted from European outflows rather than being dragged down by their European peers.

​Now that the Nasdaq 100 is getting dangerously close to its major psychological 20,000 mark, it may react in a similar fashion to the Dow Jones Industrial Average (Dow), though. It topped out at its May record high which was made marginally above the 40,000 level, a round number and thus psychological resistance. From its all-time high, the Dow slid by close to 5% within a couple of weeks and to this day trades around 3.5% lower than in May, similar to the Euro Stoxx 50.

​According to the CNN Fear and Greed Index, stock price breadth is trading in extreme fear territory. It measures the volume of shares on the New York Stock Index (NYSE) that are rising compared to the number of shares that are falling.

​Since the index uses decreasing trading volume as a signal for Fear, this measure of breadth should be taken with a pinch of salt as trading volume usually peters out around holidays like Juneteenth and over the summer months. Furthermore breadth indicators often play catch-up with their underlying markets.

​CNN Fear and Greed Index – Stock price breadth chart

​The “extreme greed” shown in the CNN Put and Call Options Index shows complacency among investors which can, at times, lead to stock market corrections.

​CNN Fear and Greed Index – Put and call options chart

​Of note is also that according to The Bank of America (BofA) Global Fund Manager Survey (FMS) sentiment is the most bullish since November 2021, lowering cash levels to a three-year low. This could potentially lead to a correction as well as no more cash is available to drive stocks higher.

​The fact that the overall CNN Fear and Greed Index has swung into “Fear” territory is counter-intuitively a positive sign for investors, though, as they are expected to re-enter the stock market or increase their share purchases once they become more positive again.

​The highest level of crowding since the technology boom in October 2020 with 69% of FMS respondents citing investments in the so called ‘Magnificent seven’ also doesn’t necessarily denote any major turning point in US stock market performance. This is because past bull markets were often accompanied by a high degree of crowded trades in just a few stocks.

​When looking at S&P 500 election year seasonal patterns since 1949, the index tends to end such years on a high, according to the AlmanacTrader.

​S&P 500 election year seasonal patterns chart: 1949-2023

​The stats look even better when a sitting US president is running, as is the case with President Joe Biden at the moment.

​Also, according to Carson Investment Research, years in which the S&P 500 has a positive January and February tend to end with a near 20% average performance, going back to 1950.

​Carson Investment Research 1950-2024 S&P 500 performance chart

​What impact would falling US stock indices have on already battered European stocks?

​If a corrective move lower in US stock indices were to occur over the summer months, it is likely that European stock indices would continue to suffer, in line with their peers. This is because US indices are seen by many as the driving force behind global stock market performance.

​Similarly, a continued rise in US equity indices should help European indices recover, once uncertainties surrounding the French elections have been put to bed in early-July, especially if Marine Le Pen’s National Rally Party does less well in the elections than is currently forecast.