Here's why stocks have tanked in August and what Wall Street expects to happen next

• The S&P 500 has dropped almost 5% in August after gaining 21% in the first seven months of 2023.
• Wall Street firms and market commentators are divided on whether stocks will resume their rally after this month.

Before August, the stock market had soared all year. The S&P 500 gained 21% through seven months as investors piled into equities and Wall Street pulled back its recession forecasts.

But over the last three weeks stocks have turned lower, with the benchmark index falling about 5%.

For more astute market watchers, this month's weak showing probably doesn't come as a surprise. History tells us that August has been the second-worst month of the year for stocks going back more than three decades, according to data from Stock Trader's Almanac, and it's particularly bad in the year before a presidential election.

But there's more to it than just seasonal woes this August.

On top of downbeat historical trends, bond yields are spiking. Interest rates have been rising as investors push out their expectations for rate cuts by the Federal Reserve. After hitting a trough this past April of about 3.68%, the 10-year Treasury is at the highest level since 2007, jumping nearly 10 basis points on Monday to hit well above 4.3%.

Recall that stocks, particularly high-growth tech stocks, are vulnerable in times of rising rates as higher borrowing costs dent profitability, while higher-yielding bonds means investors can get juicy returns from a much safer investment compared to stocks.

Meanwhile, China's economic woes are putting a damper on global growth forecasts and prompting observers to wonder how problems in the world's second-largest economy might ultimately spill over to the rest of the world.

Add Fitch's downgrade of US debt and a still-murky outlook on inflation, and the doldrums seem obvious.

Here's where Wall Street firms and market commentators see the stock market headed next.

Goldman Sachs

The firm's strategists reiterated their year-end price target of 4,700 for the S&P 500, or about 8% higher than current levels, because they don't think there's reason to fret over August's slump.

Investors still have room to "increase their exposure to equities" as the odds of a recession decline, according to Goldman, and retail activity should ramp up over the coming weeks as everyday traders turn bullish.

At the same time, the bank anticipates buybacks to soar now that the second-quarter earnings season is over.

JPMorgan

US consumers have spent all their excess savings from the pandemic, which means they have less funds to put toward stocks, JPMorgan strategists wrote in a note last week. As a result, stocks look poised to decline further.

The bank's quant guru Marko Kolanovic ultimately expects the S&P 500 to finish the year at 4,200, or about 4.4% lower than current levels.

Morgan Stanley

In an August report, analysts from Morgan Stanley's Wealth Management group pointed to spiking yields as reason to choose bonds over stocks. CIO Lisa Shalett said fixed-income assets could make for a good hedge against downside risks in the stock market.

"Investors may want to deploy incoming cash to Treasuries with 4.5% to 5.5% coupons and decent capital gains potential in scenarios where the immaculate soft landing shows signs of vulnerability," she wrote.

Fundstrat

Fundstrat's Tom Lee said Monday that investors should expect a stock rally this week thanks to two big catalysts: Jerome Powell at Jackson Hole and Nvidia's earnings.

Beyond August, Lee has predicted that the S&P 500 will notch a record high this year at 4,825, and last week he said investors should be thinking about this lastest sell-off as a dip-buying opportunity.

"We see this more as 'its August' rather than the start of a larger rout," Lee said, nodding to seasonality trends around this time of year. "We don't think the market outlook has changed into year-end 2023. In fact, this will ultimately prove to be a great buying opportunity.

Stifel

Stifel's chief equity strategist Barry Bannister told clients earlier this month that this year's strong stock rally is over, and investors should prepare for weak returns for the rest of the year.

In his words, the "no recession relief rally" has ended, and the first quarter of 2024 could still see a recession.

He expects the S&P 500 to finish the year at 4,400, which is near current levels.

Michael Burry

Last quarter, the investor of "Big Short" fame placed bets against two ETFs that track the S&P 500 and Nasdaq-100, according to SEC filings.

The two holdings could be hedges to soften the blow to Scion Asset Management's portfolio if the stock market slumps, but they could also point to outright bearishness from Burry. The two index funds are dominated by the likes of Tesla and Nvidia, and Burry has cautioned against risk-assets repeatedly in the past.

Last spring he suggested that the S&P 500 could plunge more than 50% and the Nasdaq Composite could do the same.

David Rosenberg

The president of Rosenberg research is bracing for a repeat of last year's stock slump amid prospects of higher-for-longer borrowing costs and risks coming out of China.

"It would be one thing if the S&P 500 was priced for these imperfections, but instead it is priced for perfection," he said in a video last week.

He said the equity-risk premium, or the expected difference in returns from stocks versus bonds, has tumbled to a two-decade low, and the S&P 500 looks overvalued.

He argued that investors should ditch the "uber expensive" stock market and instead look to "undervalued and deeply shorted" Treasurys.

Jeremy Grantham

In recent comments, the legendary investor and GMO founder has drawn comparisons between today's market and the dot-com bubble, and he's predicted that stocks will tumble as a recession sets in.

"I suspect inflation will never be as low as its average for the last 10 years; that we have reentered a period of moderately higher inflation and, therefore, moderately higher interest rates," Grantham said.

"In the end, life is simple. Low rates push up asset prices. Higher rates push asset prices down. We are now in an era that will average higher rates than we had for the last 10 years."