Wild stock spike revives is-this-the-bottom debate for third time this year
Another rousing recovery in equities and guess what: everyone wants to argue whether the bottom is in. That bulls have been wrong two times already in 2022 is doing little to tamp down the volume of the debate.
Not that the optimists don’t have some new arguments. This week’s stock rally, including a monster daily gain of 5.5 per cent for the S&P 500, was unlike the previous ones in that it was fueled by real progress in the Federal Reserve’s inflation battle. The dollar also fell through a key support level, China loosened some COVID restrictions and yields retreated sharply from levels not seen in a decade -- all viewed as key ingredients for a more sustainable advance to take hold.
It was more than enough for Rich Ross, the Evercore ISI chartist who was ranked as the No. 1 technical analyst in this year’s Institutional Investor survey, to call an end to the bear market that wiped out as much as US$15 trillion from equity values over 10 months.
“The bear as we know it is dead, and a new bull has begun,” Ross wrote in a note to clients Friday.
Skeptics abound. They point to the economic damage done by the Fed’s aggressive tightening and its stated intention to keep going. Forecasts for a recession next year continue to rise, and higher interest rates have finally hit Corporate America’s bottom line. Earnings bolstered all year by companies’ ability to push through price increases are now slated to contract in the fourth quarter. That would make valuations that have fallen back to historical norms look bloated again.
“I don’t think we’re out of the woods,” said Robert Tipp, chief investment strategist at PGIM Fixed Income, told Bloomberg TV.
Conflicting views on the market’s direction are nothing new, and ample fodder exists for both camps. But the stakes start to rise in a market where every attempt to buy the dip has been met with a furious reversal and major indexes are still on track for double-digit losses. Missing out on rallies like this week’s 5.9 per cent one in the S&P 500 can doom a portfolio.
Key to calling the bottom has become deciding whether the inflation trade that has defined most of 2022 has now run its course. For a week, at least, it looked as if it had. Growth stocks trounced value, lower leverage companies outperformed and tech beat energy.
That dynamic, to skeptics, was driven by buyers forced into or out of positions. Short sellers rushed to cover bearish bets as the rebound took hold, while options dealers had to purchase stocks to stay market neutral amid a flurry of hedging by under-invested money managers looking to chase the rally.
In fact, one of the market’s most reliable groups of buyers was nowhere to be found during Thursday’s rally. Day traders dumped equities in droves, selling a net US$2.65 billion in shares, the most since JPMorgan Chase & Co. began tracking the flows five years ago based on public data on exchanges.
While the exodus can be framed as a sign of capitulation that typically sets the stage for a sustained recovery, it may also reflect a deteriorating economy that’s taking a toll on Main Street sentiment. The housing market is collapsing, thanks to higher mortgage rates. And corporate layoffs are piling up.
Plot the equity rally next to corporate earnings and an odd mismatch was on display. While the S&P 500 is up 11 per cent since the end of September, analysts have cut their estimates for fourth-quarter profits and now expect a contraction.
Mike Wilson, chief U.S. equity strategist at Morgan Stanley, anticipates companies won’t be able to pass on price increases in coming quarters. While he says stocks may continue to rise in the next few weeks, the market’s ultimate bottom won’t come until 2023.
“What’s going to be new news is how significant the negative operating leverage is going to be next year for a lot of companies,” Wilson told Bloomberg TV. “We’re ultimately going to be making the final low where the big fat pitch we think is probably within three or four months.”
In the eyes of bulls like Tom Lee, however, the softer print in October’s consumer price index is a “game changer.” He drew a parallel between today and 1982, a year that marked an end of a prolonged period of runaway inflation. Back then, the S&P 500 hit the bottom in August and reached an all-time high within four months, erasing a 27 per cent bear market.
Should inflation continue to cool, the S&P 500 has a shot of rising as high as 4,500 in coming months, he said. It closed at 3,992.93 Friday.
“Softening inflationary pressures strengthen the case for a ‘soft landing,’ counter to the consensus narrative that Fed is spiraling economy to a hard landing,” said Lee, co-founder of Fundstrat Global Advisors LLC. “The soft CPI had a seismic impact.”
