If it looks like a bull market and acts like a bull market, it probably is a bull market – unless it isn’t, of course. Unfortunately, there is still a lot that can go wrong.
There are more things to be optimistic about lately. After its worst first half in decades, the
is up 15% from its mid-June low, including a 1.2% drop in the past week. The
is up 20% over the past two months, putting it in a new bull market — despite a 2.6% decline for the week. The
is up 14% from its June low after falling 0.2% for the week.
Riskier and more speculative pockets of the market led the rally, which coincided with falling bond yields. The
has gained 22% over the past eight weeks, while the technology and consumer discretionary sectors lead the S&P 500.
exchange-traded fund (ticker: XBI ) is up 40% since mid-June.
The extreme pessimism of the first half of 2022 seems a distant memory. War in Europe, runaway inflation, a looming collapse in corporate profits, a lagging Federal Reserve forced to push the economy into recession—you hardly hear about it these days.
A string of solid employment and inflation data, better-than-expected second-quarter results and a pullback in commodity prices were behind the change. Positive catalysts boosted investor sentiment: Investors’ bull/bear ratio rose from 0.60 eight weeks ago to 1.64 this past week. This means that investors who describe themselves as bulls now far outnumber bears.
There is a lot of money on the sidelines that could soon find its way into the stock market. Longtime bull Marko Kolanovic, chief global market strategist at JP Morgan, has a year-end target of 4,800 for the S&P 500—which is about 13.5% above Friday’s close and would be a record high.
“Given our core view that there will be no global recession and that inflation will ease, the variable that matters most is positioning,” he wrote on Thursday. “And the positioning is still very low…it’s now in the ~10th percentile.” That means the funds’ relative exposure to the stock market was only 10% lower than historical readings, according to Kolanovic.
Along with corporate share buybacks, he expects to see daily stock flows of several billion dollars per day over the next few months.
Even the bulls recognize that inflation is far from defeated, the Fed’s tightening cycle will continue and economic growth is guaranteed to slow. But the speed and magnitude of each of those headwinds doesn’t seem so dire now. This is a relative improvement and has the bulls wondering if a soft landing for the economy can be achieved.
This is far from a fait accompli – many things still need to be fixed. On the other hand, although headline inflation was flat in July, it was all due to a drop in oil prices. The core consumer price index, which excludes food and energy components, rose 0.3% in July, well above the Fed’s target of a 2% annual rate of price increases. And those gains were due to stickier categories, such as rents, which will not reverse like gasoline prices. Inflation remains a problem.
The minutes of the Fed’s July meeting, released on Wednesday, plus statements from a trio of Fed presidents over the past week, signaled clearly more hawkishness than the market was pricing in. But that didn’t move things much. Traders continue to bet that the Federal Reserve will back off the rate hike sooner than they have officially announced publicly. Still, the Fed, focused on tackling inflation, could still outperform the market if the data doesn’t improve further, pushing up bond yields and pushing stocks lower.
Despite the Fed’s stated intentions, the bond market is closer to declaring victory over inflation. The yield on 10-year U.S. Treasuries remained below 3 percent, down from about 3.5 percent in mid-June, even after a quarter-point rally in the past week. “What’s more, the one-year yield (the bond market’s built-in one-year inflation expectation) collapsed from 6.3% in March to 3.0% today,” Leuthold Group chief investment strategist Jim Paulsen wrote. “In fact, its decline suggests that the outlook for inflation may soon return to near the Fed’s 2% target.”
The most difficult scenario remains plausible: still high inflation combined with a deterioration in economic activity and rising unemployment. The Fed will then have to weigh its fight against inflation against supporting a faltering economy.
Management teams tended to offer bleak forecasts for the rest of the year, even if second-quarter results were generally strong. Slowing earnings growth in a suddenly not particularly cheap market along with rising interest rates is a difficult combination. The S&P 500’s forward price-to-earnings ratio has risen to nearly 19 times from about 15 times in June.
Technical analysts also see a turning point. The S&P 500 hit its 200-day moving average of around 4,321 on Tuesday, then held just below that barrier for the rest of the week.
“If the S&P 500 fails to move significantly above its 200-dma, the bears will undoubtedly conclude that the next stop will be a retest of the devil’s bottom, possibly en route to a new low before the bear market finally ends,” it wrote Yardeni Research President Ed Yardeni on Tuesday. “They have the calendar on their side because September is usually the worst month for the stock market. Since 1928, the S&P 500 has fallen an average of 1.0% per month.
Overall, both bulls and bears can point to a lot to support their case. But after a rapid rally fueled by good news and improving data, the near-term risk/reward appears to favor the bears.
Write to Nicholas Jasinski c [email protected]