The S&P 500 July rebound was something unusual. Markets rose 9.1% after an 8.4% decline in June.


Since 1960, the S&P 500 has lost 8% or more and regained at least 8% the following month on only four other occasions: in October 1974 (16.3% after -11.9% the previous month), October 2002 (8.6% after -11%), March 2009 (8.5% after -11%), and April 2020 (12.7% after -12.5%). January 2019 just missed our 8% threshold, as markets were up just 7.9% after a 9.2% decline.


These episodes have rewarded long-term oriented investors with attractive forward returns, as the chart above shows. On average, five-year returns after such declines have been roughly twice as high as the average forward return, and over 10 years the difference has been about 60 percentage points.


Clearly, the limited number of such instances in history means it is hard to draw any conclusions on what can be expected after this two-month pattern has played out. Three out of four such examples occurred during a recession, and while in 1974 markets fell 5% after the 16% rebound, in 2009 and in 2020 the rebound marked the start of recovery from recession.


However, this still highlights that just when investors would be most tempted to exit the market, they could potentially miss some substantial upside. Though market volatility can be unsettling, by staying invested investors can benefit when markets recover.


The current environment remains highly uncertain, with many unknowns regarding the Fed's hiking cycle, economic growth, and ongoing geopolitical risk. We therefore think investors shouldn't position for specific outcomes, but be diversified and include some defense against downside scenarios (slump/stagflation).


For example, we like value stocks as they would likely perform well in a soft landing scenario and think value will outperform growth until inflation falls considerably. We prefer broad value with a quality tilt, energy stocks, and the UK market. We also continue to see upside in commodity prices,


But investors should also remain diversified to be better prepared to face market volatility. Some hedge fund strategies—especially macro strategies—can perform well in recessionary scenarios, and so far this year they have broadly outperformed equity and fixed income strategies, so they can be effective diversifiers.


Main contributors: Linda Mazziotta, Vincent Heaney


Read more on CIO's short- and long-term views in the latest monthly letter Why invest now?