In the week leading up to Memorial Day, a bit of pre-summer cheer finally made its way into the stock market, but it will likely take longer than the Dow Jones Industrial Average’s first week of gains since late March to convince unsettled investors that the pain is a thing of the past.
What happened? Real or inflation-adjusted interest rates have fallen over the past week, corporate credit spreads – the yield premium over US Treasuries that investors charge when buying corporate bonds – have narrowed and investor expectations of future Federal Reserve rate hikes have weakened, noted Mahmood Noorani, CEO of research firm Quant Insight, in an interview (see chart below).
That gave some breathing room for a jump. Quant Insight’s model showed that the S&P 500 had fallen below fair value but is now right in line with the metric.
The S&P 500 SPX,
had narrowly avoided a close in bear market territory on May 19 after hitting a session low more than 20% below its record close of Jan 3. It then rose 6.6% over the past week, ending Friday 13.3% below its early January peak as it embarked on a streak of seven straight weekly declines.
The Nasdaq Composite COMP,
which remains solid in the bear market also broke a streak of seven weekly declines and is up 6.8%. The Dow’s DJIA,
A corresponding 6.8% surge marked the end of an eight-week streak of losing weeks, the longest since 1932.
Renaissance Macro Research analyst Kevin Dempter also pointed to a handful of positive factors, including a sharp slide in the US dollar, severely oversold technical conditions and extremely bearish sentiment, while some stocks, such as Nvidia Corp. NVDA,
managed to turn up despite bad news.
Opinion: The S&P 500 may find a near-term bottom – but medium-term concerns remain
However, neither Noorani nor Dempter were willing to declare a market floor. And there was no shortage of downright bearish expectations. Michael Burry, the founder of Scion Asset Management, rose to fame after foreseeing the collapse of the US housing market as chronicled in the book The Big Short by Michael Lewis. A since-deleted tweet suggested parallels to the 2008 market crash.
In a fresh Friday tweet, he mused on the prospects of a consumer-led recession:
This reflects fears expressed in early May when retailers targeted TGT,
and Walmart WMT,
reported disappointing earnings, exacerbating the sell-off in stock markets on fears that inflationary pressures could start to weigh on corporate earnings numbers.
A further fall in real yields could allow stocks to keep climbing in the short term, Noorani said, but he argued yields were unlikely to have peaked.
Because while data, including Friday’s personal consumption spending index, the Fed’s preferred indicator of inflation, show inflation is slowing, the job of bringing price pressures back under control is far from over, he argued.
That leaves uncertainty about how high the federal funds rate will eventually rise from the current 0.75% to 1%. Market prices are pointing to a so-called final rate of between 2.5% and 3%, but anything that suggests it will be higher will unsettle investors, he said.
The key driver of yields “will be Fed policy,” he said, noting that central bankers “were spooked by inflation at these historically high numbers.” While it’s painful for the real economy, “they have to hit the brakes pretty hard and bring those numbers down.”
While the S&P 500 hasn’t technically confirmed that it’s in a bear market, many market watchers are taking it as a mere formality, observing that stocks have exhibited bear-like behavior throughout much of the 2022 sell-off.
Dempter, in a note on Friday, downplayed the sharp outperformance of the consumer discretionary sector versus the rest of the market in the previous session, acknowledging that historically, consumer discretionary would see a sharp improvement in relative performance about a month ahead of growth lows. The move is likely an oversold bounce rather than a bottom, he argued, noting that RenMac would be more optimistic “if growth had been weaker and inflation had peaked.”
“History suggests that both growth and inflation will need to moderate further before bottoming out,” he said, noting that the energy sector’s continued outperformance of healthcare suggests inflation is yet to peak has not reached.
Continue reading: This Stock Market Indicator Says Investors Don’t Think Inflation Has Peaked: Analyst
“We’re looking at the ISM next week [manufacturing index] number as a weak read could move the market cycle clock closer to a more favorable zone for a bottom,” he said.
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