The stock market is rapidly getting healthier. Why that sets up another big year-end rally.

• US stocks shed their early-August losses and can maintain their momentum into the fall.
• A broader, healthier rally will soon lead to new highs, according to Ned Davis Research.
• Top strategist Tim Hayes shares the two sectors that can benefit most in this backdrop.

A strategy chief with a knack for calling rallies is giving US stocks an all-clear signal once again.

Nearly a year ago, Tim Hayes of Ned Davis Research said the S&P 500 would shake off its early-August slump and enjoy a strong year-end surge , reasoning that the bull market had legs. The chief global investment strategist's call proved to be eerily accurate, as the index came within inches of his ambitious 4,800 target, which it topped a few weeks later.

Much has changed since last September, but Hayes' call is virtually unchanged. This year's early-August drawdown is little more than typical seasonal turbulence , in his view. And while elections will bring more market swings, he believes US stocks are destined to hit new highs.

"When we wrote about the outlook for this year , we said it would probably be a year where we're going to have a couple corrections, some sort of a choppy sideways period in summer and mid-year going into the fall — but then we would come out of it at the end of the year, and we'd end the year at new highs," Hayes said in a recent interview. He added that there's "no reason to think that that's not still the higher probability."

A breadth of fresh air

The S&P 500 was stuck in place for the second half of August after a powerful eight-day-long rebound that erased its monthly losses, but that pause masked a major market development.

While US stocks in aggregate took a breather, breadth improved significantly, Hayes said in a late-August note. A greater swath of stocks rising makes for a healthier market that's less reliant on a handful of large companies, as has mostly been the case since the start of 2023.

Hayes and his team have been focused on market concentration throughout the year. This summer, the 10 largest stocks made up a staggering 24% of the MSCI All Country World Index, which was the highest rate on record, according to Ned Davis Research. That figure has fallen in the last few weeks to 22%, which is still uncomfortably high but is a marked improvement.

"The combination of concentration diminishing and then the breadth improving is what you want to see," Hayes said. "That's picking up that rotation, the shift away from tech into other areas."

To that point, it's not just that mega caps have taken up a slightly smaller share of global markets since the early-August drawdown. Hayes noted that other stocks, including economically sensitive ones, have also risen on a relative basis recently.

Cyclicals have performed better since lower inflation will give the Federal Reserve clearance to cut interest rates in September for the first time since the onset of the pandemic. That should support the economy and boost cyclicals' earnings growth and profitability, helping them catch up to their high-flying growth peers.

"Rather than a rebound dominated by the mega caps, the recovery has been broad, with investors responding to central bank easing cycles and economic soft landing evidence," Hayes wrote in his note.

This broadening is perhaps best illustrated by the percentage of stocks trading above their 10-day moving averages, which topped 91% on August 19, according to Ned Davis Research. Another bullish indicator shows that stocks are advancing more than they're declining.

When these indicators have flashed similar signals in the past, a rally has historically followed about 76% of the time, Hayes noted. He added that the typical outcome in such scenarios is an 8% gain that lasts about two months. If history repeats, the S&P 500 would reach the 6,050 mark by November, though Hayes refrained from making a specific prediction for the index.

If US stocks do have serious upside ahead, Hayes said he'd shift toward companies in the financials and real estate sectors. That's a departure from his recommendations last year of small caps, consumer discretionary, industrials, and technology.

Both groups have taken off recently since they're expected to be among the biggest beneficiaries from lower interest rates. Valuations are another massive tailwind, as stock-pickers are shifting from expensive parts of the market to cheaper areas.

"Investors are more confident going into and making a bet on these areas that had gotten relatively cheap," Hayes said.