Evening Brief – 10.12.23
Can the Bear Market Rally Continue?
The equity market rally that lasted through the second and third quarters has waned, but the market is still poised to achieve one of its best calendar-year gains in decades. The obvious limitation is that a lot can happen between now and the end of the year.
The question as to whether this year’s gains represent a bear-market rally continues. One reason to think about it is that the market has yet to regain its January 2022 high.
When compared to previous calendar-year outcomes, the rally in the S&P 500 this year has continued to produce a high return. Although encouraging, it is still early to abandon the notion that the market is in a bear-market rebound. The recovery has recently stalled, raising new concerns about what may happen next.
Despite a year-to-date rise of more than 13%, the S&P has yet to fully recover its heavy losses in 2022. The current peak-to-trough decline of 8.7% predicts that bear market conditions will persist until the prior peak in January 2022 is recaptured and remains convincingly above it.
One reason to expect stock market headwinds in the immediate term is the recent increase in US Treasury yields. The long-term projected return on stocks is arguably higher, but the spread between equity returns and the 10-year US Treasury yield (4.70) has undoubtedly decreased by more than a hair in recent weeks.
As investors compare the risk-free return on government bonds against the greater but significantly more unpredictable and uncertain ex-ante performance of equities, the rationale for reducing equity allocations has grown.
The argument in favor of equities is that the economy is still expected to grow at a quicker rate in the third quarter, while corporate earnings are expected to rebound. Meanwhile, there is more evidence that the Federal Reserve’s rate hikes are coming to an end.
Of course, there are always risks, and the stock market in general tends to climb a wall of worry. Will that historical precedence be followed? Most likely, but in due course. In the short term, though, it’s difficult to see a sustained rise that wipes out the previous 2022 high.
The momentum that sent equities higher a year ago was founded on an extremely oversold state. With that catalyst no longer there, investors must evaluate what catalysts can propel the market over its previous high?