The S&P 500 resumed its pullback late last week, driven by escalating fears of a hard landing following disappointing economic data, RBC Capital said in a note Monday.
Initially, the market showed signs of stabilization, bolstered by expectations of a rate cut in September following Wednesday's Federal Reserve meeting.
However, weaker-than-expected ISM and jobs reports reignited concerns about economic downturns and policy missteps. By Friday's close, the S&P 500 had declined 5.7% from its July high, a pullback slightly more severe than April's but not as deep as last fall's 10% drop.
RBC Capital analysts emphasize that while economic data triggered the downturn, the U.S. equity market was already vulnerable to a pullback.
"Some of the things that have had us worried have included stretched sentiment and positioning, the stock market's poor seasonal track record in August through October in recent years," wrote the bank.
Despite these issues, RBC notes that the market managed to post a positive return in July before faltering in August.
They highlight sentiment indicators, such as the AAII survey, which showed a rise in net bullish sentiment to 22%, near levels that often signal short-term market peaks.
Additionally, RBC says U.S. equity futures positioning remains at all-time highs, further indicating market vulnerability.
RBC told investors that valuation models suggest the S&P 500 had already factored in several rate cuts for the year, making the recent pullback a natural market reaction.
"The history of stock market declines following the onset of past cutting cycles tells us this is a natural debate to have right now," said RBC.
Given these dynamics, RBC predicts that the current pullback could settle in the 5-10% range, though they are closely monitoring economic indicators, particularly job reports, for signs of deeper growth scares.
"We still have questions about the jobs report, specifically on weather. For now, 10% remains our assumption for how deep a pullback could go, but we’re monitoring the jobs discussion closely for risk of a growth scare settling in given how skittish investors appear to be," the bank concluded.