Welcome to one of the best-predicted bear-market rallies in recent history. For all the gloom about recession risk and rising borrowing costs, many prognosticators accurately predicted that stocks were poised for a rebound, which has materialized in the form of a 6.4% bounce in the S&P 500 Index since the June 16 low.
Now, several strategists think the index has room to run, including two who have recently been at opposite ends of bull-bear spectrum. Morgan Stanley strategist Michael Wilson, a prominent bear, said in a note that the S&P 500 may climb an additional 7% or so, echoing similar sentiment Friday from JPMorgan Chase & Co.’s Marko Kolanovic, a well-known bull and the No. 1 equity-linked strategist in the last Institutional Investor survey.
Monday’s slight pullback notwithstanding, there are good reasons to believe Wilson and Kolanovic are right about the market’s upside, at least in the short term. For starters, both strategists noted the tailwind from institutional investors, including pension funds rebalancing their portfolios before the end of the month.
There’s also a lack of genuine downside catalysts on the horizon as markets navigate the summer doldrums. The bear market of 2022 has been marked, first, by an adjustment to higher interest rates — and therefore lower price-earnings multiples — and, second, by the growing expectation that a possible recession will cut into companies’ profits.
Consider the rates outlook. As Bloomberg Economics chief U.S. economist Anna Wong noted Monday on a conference call, two key factors that drove the Fed to undertake its biggest rate increase in 28 years have now reversed: Oil prices that shot up in the first part of June are now in a bear market, while inflation expectations aren’t as out of control as the Fed initially thought after a preliminary survey reading from the University of Michigan. There’s a growing chance that the Fed could shift next month back to a regimen of 0.50 percentage point rate increases — instead of the 75 basis points it moved this month.
Next there are earnings expectations. With even the most bearish economists mostly assuming a recession won’t come until 2023, corporate profits are in a state of suspended animation. The economy is certainly slowing, but it’s coming down from a breakneck pace; unemployment remains extremely low; and consumers continue to lean on household cash reserves and wealth accumulated during the pandemic to keep spending. While the good times won’t last forever, it’s hard to see the definitive signs of an earnings recession emerging in the coming months. In the meantime, the bulls can continue to hang their hats on the perfectly decent numbers already in hand.
Between the two risks, interest rates may pose the greatest near-term threat. The Fed is behind the curve in fighting the worst inflation in 40 years, and it’s still likely to push the fed funds rate to about 3.5% by the end of the year. To the extent that markets are hoping for a wholesale dovish pivot, they may find it elusive in 2022. Fed Chair Powell has said that his focus is on the inflation side of his mandate over employment, and as he said at his June 15 press conference, he wants to see a “series of declining monthly readings” to know that the Fed’s strategy is working on prices.
If you assume a “series” is at least three, that leaves almost no chance of a significant shift in strategy until the Fed’s meeting on Sept. 21. If the July 13 consumer price index report continues to show strong underlying inflation, the Fed will leave the door open to a jumbo-sized rate increase next month, and the timeline for such a pivot will be pushed back even further.
It’s unusual for Kolanovic and Wilson to agree on much these days — even if it’s just a short-term call, but this one makes sense. In the longer run, investors should be careful not to interpret this summer respite as the end of the bear. As Wilson himself put it in his note, these markets have a tendency “to confound all market participants at times, even the bears.” Trading isn’t supposed to be easy, and the next surprise always just around the corner — that’s the one consensus that’s worth trusting unconditionally.More From Other Writers at Bloomberg Opinion:
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.
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