The following is the S&P 500 chart in 2004.
*Read the entire history of the U.S. stock market here.
Q4 2003 earnings (released in January 2004) were very good across almost all sectors. The S&P rallied throughout this earnings season.
January 28, 2004: The Fed unexpectedly changed the wording in its policy statement at the FOMC meeting, dropping a promise to hold rates steady for a “considerable period” and saying instead that they would be “patient” in keeping rates low. Thus, investors started to expect the beginning of a rate hike cycle.
The S&P fell 6.5% (March 5 – March 24) in the first leg of the May-August 2004 correction. There were no fundamentals or news related to this decline at all. However, our model still predicted this small correction beforehand, and we knew that it would not be a big correction.
The S&P slowly grinded down in mid-April 2004 (during Q1 2003 earnings season) even though earnings reports beat estimates across the board (despite very high estimates!).
May 4, 2004: The Fed held an FOMC meeting. Investors start to think that the first rate hike will most likely happen at the Fed’s August meeting. The market also believes that there’s a smaller chance that the Fed will hike rates in June (the soonest meeting after the one in May).
Rising oil prices became a concern for the first time in mid-May when oil made a new all-time highs above $40. $40 was the previous all time highs in 1980 and 1990. Rising oil prices impacted inflation, which impacted potential future rate hikes.
Oil prices slightly dipped below $40 in June 2004. Then oil surged past $40 in July 2004 and never looked back. This was the beginning of a weak inverse correlation between oil and the S&P, which would last forseveral years (until July 2008). Since the overall correlation was very weak, it was impossible to use this correlation to predict the S&P’s future price movements. Thus stock investors should have ignored oil prices.
By early-June, the Fed Funds futures showed that the market predicted a 100% chance of a rate hike at the Fed’s June 30 meeting. Random comments from Fed governors and Greenspan at random events/speeches reinforced this view.
June 30, 2004: The Fed hiked rates for the first time in years. The S&P went up 1 day on this news, then fell slowly and steadily throughout all of July, including during the upbeat Q2 2004 earnings season.
The media relied on a common excuse during the March-August correction: “the S&P is falling because oil is rising”. This weak inverse correlation only worked sometimes. For example, the last leg of the correction (all of July and early-August) saw oil rise while the S&P fell.
The S&P bottomed on August 13 and started to rally strongly while oil surged. This demonstrates that it’s impossible to predict when a correlation will break. There was no fundamental news that caused the S&P to bottom on August 13.