Investors are looking for signs that this rally could find some traction
We have been here before, more than once and not so long ago. The S&P 500 closed the week at around 3,900. The index first hit this level 17 months ago on the upside and again in May on the downside, ending at 3,900.86 on the 10th. June. This time, the index hits the level with a 7% rebound. It’s one of half a dozen rebounds of 5% or more this year, averaging about one a month, that halted but didn’t stop the slide that began Jan. 3. The question hanging over Wall Street is also now familiar: Is there something different about the current bounce attempt that makes it more likely to travel further in time and distance than those that broke out and failed? previously ? The answer, of course, remains to be determined. The scale and strength of the rally since mid-June has yet to surpass the status of an “oversold bear market rally”. Each of the S&P 500’s brief rebounds this year have touched or briefly exceeded its 20-day average, a short-term trend indicator that frequently contains rallies in falling markets. A notable test for the S&P 500 With another 2% to 3% gain, the index will have a more notable test: its 50-day average and the 4,000 level from which it fell badly in June. This means that the burden of proof is still on the optimists who say this is the real upswing, from a purely technical standpoint. Still, a few elements arguably distinguish the current upside effort from the failed forays of the past six months. On the one hand, this rally phase began with the lowest valuation, the deepest oversold conditions and the most depressed investor sentiment backdrop of all the short-lived rallies that preceded it. The S&P 500 fell below 16 times forecast earnings for the next 12 months. This is by no means a generational bargain, but about as much compared to the peak in valuation that bearish markets have tended to get – with a few nasty glaring exceptions. This Truist chart showing the degree of adjustment in valuations is a picture of foam rising and optimism seeping out of equities. As with so many historical patterns that now compare closely to the current setup, the odds are starting to favor good returns months or years from now – unless we’re in something like corporate distress shrouded in recession over several years bearish as in the early 2000s or during the Great Financial Crisis. Estimates are falling Discussions of helpful valuation compression already on the books are quickly shouted by those who counter that the consensus earnings forecast simply needs to drop and it will shock the market even though almost everyone has been talking about it and stocks just had their worst half in a generation. Certainly, the general consensus forecast for the S&P 500 has held collectively and even for the second quarter, it is expected to rise by around 4%. Yet outside of energy and materials, analysts have steadily cut their estimates – with a net 25% to 40% of companies in the industrials, technology, communications services and consumer sectors. discretionary investors who are seeing their projected earnings fall, according to Bespoke Investment Group. The Leuthold Group looked at the performance of the S&P 500 before and after peak earnings in the only four periods since 1995, when 12-month forward earnings fell significantly. The analysis aimed to show how stocks fare once estimates begin to fall. Yet, in all previous cases, the index was up in the six months preceding the peak estimate. Over the past six months, the S&P has lost almost 20%, so perhaps the market is not oblivious to the potential risk to earnings? Confidence indicators haven’t been particularly helpful this year, given the relentless bearish momentum and ever-tightening financial conditions. Yet, at other extreme extremes, the forces of mean reversion and contrary logic should become tailwinds. The 52-week average of optimistic respondents to the American Association of Individual Investors’ weekly retail investor survey is now below 30%, a fairly rare degree of slow redemption seen only a few times over 35 years, the last in 2016. speculators’ accounts are now as severely short as they have been since 2020. Has inflation fever died down? On the macroeconomic front, the current rise in equities has been accompanied by market-implied future inflation expectations at around their lows for the year, a sign that the fever of supposedly indomitable inflation is brewing. is appeased. This coincided with Treasury yields sitting below their stock market low in June. For now, bonds are doing better holding their value rather than exacerbating a bad year in equities. This is all fairly tentative and dependent on the latest data release, but for now, it eases some of the pressure on stocks. On a more impressionistic level, each of the past five trading days has seen the market weaken overnight or into the morning, followed by a bid that drove the index much higher at the close. This is by no means clear cut, but it does at least suggest that professional investors are underexposed to stocks entering the second half after two rare consecutive quarters of 10% declines. The sharp and deep correction in crude oil, other commodities and energy stocks has not negated long-term uptrends, but has certainly eliminated the only remaining pocket of momentum and overconfidence in the markets, a healthy event all other things being equal. Growth stocks have been outperforming for weeks and the Russell 1000 Growth relative to value is bumping up against its months-long downtrend. When big growth names perform well, they tend to be more supportive of the S&P 500 – although it’s far too early to declare a drastic shift in their direction. A Major Challenge Remains None of this eliminates the overarching challenge that investors have faced all year: a slowing economy and a mature profit cycle coinciding with an aggressive Federal Reserve determined to chase inflation and indifferent to looking for opportunities to relax. Friday’s jobs health report eased immediate recession concerns, but it will only keep the Fed focused solely on inflation. Credit markets have firmed up a lot in the past two days, but they had been worrying for weeks about a weaker economy. Rightly or wrongly, we are at a point where the market seems to think it is now more in tune with the likely political trajectory, easily absorbing official Fed speeches last week as the bond market sees rates at short term peak in several months. Yet Wall Street believed it at other times this year and learned a hard lesson. So, of course, some things are different around the last little rally. Whether it’s different enough in the right ways to give that rebound some exhaust velocity remains to be proven.
