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Here’s what could go wrong with stocks at record highs

Strategas Research’s head policy analyst, Daniel Clifton, says he calls the budget debate the “spinach” portion of the Republican agenda, the part that Congress has to work through before it can get to tax reform. The budget for fiscal 2018 contains reconciliation instructions for tax reform which would allow the Senate to pass tax policy with just 51 votes.

“Failure to raise the debt ceiling could lead to financial market complications, as we learned in 2011. We expect both the budget and debt ceiling to be completed, but rarely does the process invoke confidence in policy-making,” wrote Clifton. If stocks sell off, however, he sees it as an opportunity to buy the dip.

“We’ve gone a long time without a correction, but that’s something you could have said three months ago. Just because you’re at the roulette table, you could be overdue for black but you keep coming up red. Concerns about valuations have been around for a year now,” said Paul Hickey, co-founder of Bespoke.

Hickey said one thing that could trigger a correction is if the economic data begin to make it seem that the Fed is going in the wrong direction, or is even behind the curve and has to play catch up with interest rate hikes. The market is currently not convinced the central bank will raise rates again this year, as it has forecast.

But the Fed is expected to begin the process of unwinding its balance sheet in August, by buying fewer Treasury and mortgage securities. Some strategists say that process could spook the market if it causes interest rates to rise.

Hickey points out that the S&P 500 has actually fared worse in the seven summers since the bull market began, declining an average 1.7 percent in August.

Source: Bespoke

In the past 20 years, August has been the worst month of the year for the Dow and the S&P 500, both lower half the time and averaging declines of about 1.5 percent, according to analytics firm Kensho. September has been the third worst month for stocks, with the Dow down an average 1 percent and negative 55 percent of the time. The S&P has been down an average 0.75 percent and was lower half the time in September.

But for now, Hickey doesn’t see some of the red flags that would signal a correction. “The high-yield market has been holding up well,” he said. Earnings have also been strong, with second-quarter profit gains coming in at about 10 percent, according to Thomson Reuters.

“It’s not a bright green light, but it’s not flashing red either,” he said. Hickey said other summers have had their unexpected surprises, like 2015 when China’s economy was slowing or 2014 when there were concerns about ebola.

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