The first half of 2022 was the worst first half of the year for the S&P in more than 50 years. But since the beginning of the second half of the year, the market has begun to rebound. The S&P 500 is up 13% from its June lows, and the NASDAQ is up near 20% from its lows, and close to the hypothetical threshold for a new bull market.
When we see this rally, our main question is: are we looking at a new bull market or is this a bear market rally? In other words, have we reached the bottom yet and are on our way up, or is the market seeing a small rally before another plunge?
To answer this question, lets understand what is driving this rally.
- Capitulated investor sentiment: The implication is that the market has reached its bottom as the price has been driven down by investors selling stocks without the hope of regaining their losses. Thus, the market is ripe for a rally.
- Q2 earnings exceeded expectations: Many investors were worried that as stocks plummeted, this downturn would also be reflected in their earnings report. However, the reports were not nearly as bad as many feared.
- Investors are hoping for an inflation decline and an end to the Fed hiking interest rates by the end of the year.
As the market rallies, the US Federal Reserve is concerned that this is occurring prematurely, before the necessary economic goals have been achieved.
Is this the one?
Bear rallies happen often, and this has indeed been a big one. Compared to the three previous major crashes in 2007, 2000, and 1973, two things stand out:
- The large number of bear rallies which typically occur before the one that is sustainable arrives and starts the next bull market. We are currently in the 4th rally, and some recoveries have needed 11.
- The large size of this 13% rally versus the 8% average bear market rally. History indicates that we may have more false dawns ahead, and the size of this rally, though big, is not unprecedented.
Inflation must come down
To reach the sustainable rally that will lead to the next bull market, we need to see a sustained decline in inflation. We believe we are close to this inflation peak, with commodity prices falling, supply chains loosening, and the labour market starting to weaken. Despite these signals, we will need to see concrete data that inflation is coming down, which still may not convince the Fed that it is time to halt interest rate hikes.
We remain optimistic that we may have seen the bear market reach its bottom but at the same time cautious about the current rally being the sustainable recovery that will lead to the next bull market. For that to happen, inflation still needs to come down.
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