It appears that we’re at the tail end of the dog days of summer, and while they’ve certainly been true to form in bringing hot and humid weather, this July-August period has also delivered considerable stock market gains in a year in which those have been rather hard to come by.
The S&P 500 is coming off its fourth straight week of gains, rallying 17% from its mid-June low and marking the index’s longest winning streak since 2021. It should also be noted that the S&P has retraced 50% of its losses from its high on January 3 to the June 16 low.
Technically speaking, we are in a recession in the sense that we’ve seen two consecutive quarters of economic contraction. Yet so-called experts like Jerome Powell are quick to remind us, certain recessionary hallmarks are notably lacking—one of which is a slow-down in the labour market. The July jobs report indicated that total nonfarm payroll employment (number of workers in the U.S. excluding farm workers and workers in a few other job classifications) rose by 528,000, easily blowing the 258,000 estimate out of the water. Furthermore, the unemployment rate (3.5%) came in lower than anticipated (3.6%), and wage growth also surged. Despite initially reacting negatively to this news as it could mean another, more aggressive rate hike from the Fed to cool the economy and more specifically the hot labour market, the market quickly began to celebrate the prospects of the Fed achieving a soft landing (where demand and prices are reined in without tipping the economy into recession).
Additionally, the monthly inflation numbers for July have added to the momentum of this market rebound. The Consumer Price Index (CPI) came in at 8.5% YoY (See Exhibit A), meaning that the same goods this July cost 8.5% more than last July, which was less than economists’ projections of 8.7%. The CPI registered a 40-year high of 9.1% in June, so it’s safe to say that investors were relieved to see that number go down. On a month-to-month basis, there was no change from June to July, further supporting hopes that inflation has peaked. Although inflation may be peaking, price growth is still historically high, and household budgets will continue to experience price pressures.
Just like how it’s important to keep your emotions in check when the stock market is heading south, investors must stay even-keeled during this market surge. Some market insiders like Sam Stovall of CFRA Research believe that the 50% retracement level is a sign of a permanent market reversal, saying that “History reminds us that in every bear market since World War II, the S&P 500 never set a lower low after recovering 50% of that peak-to-trough decline…history says the low is already in.” While he’s certainly not the lone market expert with that opinion, I’m having trouble being as optimistic that we’re entering the next bull market. Instead, I’m envisioning a bear market rally, a term for a temporary increase in stock prices during a bear market (hence the title of this post), only to give up those gains and fall further.
If you take a look at previous bear markets you’ll see that is quite a common occurrence for stocks to have significant, long-lasting rallies. During the Tech Crash (a.k.a the Dot-Com or Tech Bubble), the S&P saw four rallies ranging from 10% to 25% in price return and from two weeks to 2.5 months in duration. Similarly, the Housing Crash had four rallies of its own, returning 10%-15% and lasting one to two months each. With that context in mind, after looking at the current stock market rally, which after 9 weeks (just over 2 months) has increased about 18%, personally I’m definitely not ready to hop in the bull camp.
If that’s the case, and this really is just a temporary surge, then the question remains, when will it end? When can we expect the fall? While that question is impossible to answer without a time machine, investors might be able to get an indication from the S&P’s 200-day moving average (the average price over the previous 200 days), which historically has provided great insight during bear markets. Looking at notable rallies in November 2000 (Tech Bubble) and May 2008 (Housing Crash), the S&P 500 was unable to break above its 200-DMA in either case, which, as Mark Arbeter of Arbeter Investments notes, “were both last gasp attempts by the bulls before the real downside started.” Yesterday (Aug. 16) the S&P came within a single point of its 200-DMA before pulling back (See Exhibit B, where blue line represents the 200-DMA), so keep an eye out to see if it can break through the resistance of the 200-DMA in the coming days. If history is any indication, failure to do so will result in a downward trend for stocks beginning in the next few weeks.
The way I see it, we’re far from being out of the woods; there are still so many question marks when it comes to this economy. I’ve given my opinion on potentially disregarding the 50% retracement rule in favour of the more bearish 200-DMA indicator, but the reality is nobody has a crystal ball. All I can suggest is just don’t celebrate too much if the market keeps going up, and don’t be surprised if it starts a sharp decline (and maybe keep some cash on hand for if this situation does materialize).