(Bloomberg) — The buying frenzy that has driven the US stock market virtually uninterrupted for four months is approaching a point where past rallies have cooled.
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It’s in the chart, with the S&P 500’s rally reaching the halfway mark like the one that spelled the fates of the bulls in August. This week also marks the first big hit of the year for the bulls. with a buy-on-bearish strategy that by some measure has been as strong as any year since 1928. And warnings are blaring from the bond, its bullish thrust has created cover. to stock loyalists who believe they will weather the worst the Federal Reserve has to come up with.
Signs of disappointment had also appeared a week earlier among hedge funds, which had their biggest position cuts in two years, according to data from Goldman Sachs Group Inc.. The S&P 500 has fallen 1.1% over the past five days, marking its worst week since mid-December.
While a bad time doesn’t prove anything, it does highlight the risk of a bull run that has inflated stock prices to $5 trillion at a time when central banks say that Their anti-inflation campaign could be years away and earnings and economic data continue to crater. Buying stocks now means looking at high valuations by most historical standards and betting against an ever-unified class of experts with the view that stocks must be reckoned with. .
“The first half of the year will likely see the impact of rate hikes starting in early 2022, which will ultimately affect the economy,” said Tom Hainlin, country investment strategist at US Bank Wealth Management. economy. “We won’t have much confidence that the rally we saw in early 2023 is sustainable until we see the impact of rate hikes on the real economy.”
The cause of the week’s losses was concerns that the Fed could raise interest rates above 5%, potentially to 6%, to slow demand. The yield on the two-year Treasury note jumped more than 20 basis points to above 4.50%, its biggest weekly gain since November.
The aggressive stock buying halted ahead of January’s consumer price index, due out on Tuesday, which should shed light on the Fed’s progress in its fight to contain inflation. US hedge funds were withdrawn $7.7 billion in the week to February 8, according to a note from Bank of America Corp. citing EPFR Global data.
Stocks have had a solid start to the year, helped by signs of subdued inflation and better-than-feared fourth-quarter earnings. That went against all the warnings from the sellers that a tough first half was coming. Meme stocks have rallied as day traders return, while riskier stocks, such as loss-making tech companies, skyrocketed, possibly fueled by compensating offsets forced by short sellers. Despite lackluster profits at large-cap companies, a series of job cuts spurred stock rallies like Walt Disney Co. and Meta Platforms Inc.
At the start of this month, nearly 80% of S&P 500 stocks traded above their 200-day moving average. Such market breadth has, among other things, sparked calls that a new bull market has begun.
Partially fueled by the retail crowd whose post-pandemic buying strategy has proven successful, the New Year’s rally has been largely driven by a big drive to bargain. In fact, the S&P 500 gained an average of 0.45% the day after the drop, a stronger rebound than in any year since 1928.
“The buying sentiment when prices fall is driven by the idea that when economic growth slows, the Fed will force a pullback,” said Lauren Goodwin, chief economist and portfolio strategist at New York Life Investments. must reverse its policy approach”. “The dip buying story is one that I really don’t expect to prevail or succeed as interest rates remain in the confines.”
When forces like short-term offsetting or retail euphoria are in play, putting faith in the charts can be dangerous. Consider the well-known 50% retracement indicator that is often touted as an almost certain signal that a rally will have legs. At a peak close of 4,180 on February 2, the S&P 500 erased half of the peak-to-trough decline incurred over the last year. Then it fell in four of the next six sessions.
If the pullback continues, it will mark the second time in a year that the indicator has failed to meet its payout claim. A similar signal appeared in mid-August, raising hopes that the worst was over. Then the sell-off continued and the stock dropped to a new low two months later.
In many ways, the rally that has lifted the S&P 500 up 17% from the October low contradicts a deteriorating fundamental story. Outside of the labor market, the economy has weakened, as evidenced by data on retail sales and manufacturing. Recession warnings in the bond market are growing louder, with the yield spread between 2-year and 10-year Treasuries reaching their deepest inverse in four decades.
Furthermore, analysts’ estimates of how much U.S. businesses will earn in 2023 have consistently declined. Since late October, expected earnings have fallen 5% to $220.7 per share, data compiled by Bloomberg Intelligence shows.
Falling earnings sentiment can cause trouble in the market when stocks are already expensive. With 18.3x returns, the S&P 500’s multiple is well above its 10-year average. When stacked in cash, which is currently making the most money in years after the Fed raised interest rates, the index’s earnings yield fell to a 15-year low.
While the latest rally has baffled money managers, who have been largely on the defensive, there are signs that few are willing to embrace the rally. In fact, hedge funds tracked by Goldman’s top brokerage last week cut their long-term holdings as stocks rallied.
“I don’t think the valuation will support a further bull run here,” said Jake Schurmeier, portfolio manager at Harbor Capital Advisors. “And I would take retail enthusiasm as a sign that the market is boiling again, which I think the Fed would also consider a bit worrisome if the economic fundamentals do not continue to support that.”
–With support from Vildana Hajric.
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