Is the ‘Bottom In’ or Is This a Bear Market Rally?

Analysts are split over what's been driving market movements in recent days. Despite ongoing fears of a coming recession – or that it has begun – investors have been buying up equities fast, and market indices are pumping.

The rebound started after investors heard dovish words from Federal Reserve Chair Jerome Powell after the central bank announced a rate hike of 0.75 percentage points on Wednesday, July 27.

The S&P 500 shot up nearly 4% over the following two days, triggering rampant speculation in the financial media over where the markets are heading. It begs the question – have we reached the bottom of this year's market downturn, or is this just a temporary rebound amid a longer, deeper bear market?

Onwards and Upwards

The forecast is blue skies ahead, according to Tom Lee of research firm Fundstrat.

“The biggest takeaway for me on events of this week? Convincing and arguably decisive evidence the ‘bottom is in' — the 2022 bear market is over,” he told Business Insider.

Lee says the stock market could reach new heights before the year is out. He cited a historical precedent of 1982 when the Fed was also jacking up rates to beat inflation. Lee posits that if Powell follows the same steps his predecessor Paul Volcker took back then, investors could see record peaks over the coming months.

Lee also pointed to better-than-expected earnings from the second quarter as evidence that things are improving. Roughly three in four of the S&P 500 companies that reported second-quarter earnings exceeded their quarterly estimates by 7%. Impressive results from mega-caps like Apple, Alphabet, and Amazon have also spurred the rally on.

Another analyst who broadly shares Lee's outlook is Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets. In a note to investors, Calvasina stated that RBC increased its equities exposure. She reasoned that a potential recession might already have been baked into stock prices.

“We think it's possible that the S&P 500 has already bottomed, and if it hasn't, will find a bottom during the third quarter,” Calvasina said.

Not So Fast…

Others expect short-term gains in the coming weeks, though they are less optimistic about the rest of the year.

Last week, a Bank of America (BofA) Global Research survey showed expectations for global growth and profits among fund managers at all-time lows. The managers also indicated that cash, as a portion of portfolio allocation, was at its highest in two decades. BofA strategists interpreted these contrarian indicators as a sign of more significant stock gains ahead.

BofA strategists said this showed a “dire level of investor pessimism” and interpreted these contrarian indicators as paving the way for market rebounds ahead.

“Second half 2022 fundamentals are poor, but sentiment says stocks/credit rally in coming weeks,” BofA strategists wrote.

 Buyer Beware

Yet analysts at Morgan Stanley don't see much upside to the current bounce. Mike Wilson, the investment bank's chief U.S. equity strategist and chief investment officer, is warning investors against jumping in, calling the post-rate-hike rally a “trap.”

“The market always rallies once the Fed stops hiking until the recession begins. [But] it's unlikely there's going to be much of a gap this time between the end of the Fed hiking campaign and the recession,″ he told CNBC's “Fast Money. “Ultimately, this will be a trap.”

Wilson sees the current rally as driven by investor expectations that the Fed will start to ease off rate hikes as the economy edges closer to recession.

“The problem with this thinking, beyond a near-term rally, is that it's unlikely the Fed is going to pause early enough to save the cycle,” Wilson wrote in his Monday research note.

Even if a recession eventually brings rate cuts (typically good for equities), companies will struggle to post high earnings in a contracting economy. He predicts investors could pay the price for being overly focused on rates now and not heeding the dire warnings about the downturn in the broader economy.

“We remain skeptical that the Fed can reverse the negative trends for demand that are now well established,” he said.

Wilson predicts the S&P 500 will close the year out at 3,900 – around 4% lower than where it is now. However, if a recession bites hard, he sees that plummeting to 3,000 – vanquishing about a quarter of the index's value.

Rocky Road Ahead

Historically, determining where we are in the economic cycle has been difficult for investors. The arrival of geopolitical conflict, pandemics and other black swan events make it even harder to see the way forward. The silver lining for investors is that all the analysts discussed, including Wilson, see the current bear market coming to an end at some stage – they just remain split on when that will be.

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This article was produced and syndicated by Wealth of Geeks.

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Liam Gibson is a journalist based in Taiwan who regularly publishes in Al Jazeera, Nikkei Asia Review, Straits Times, and other international outlets. He also runs Policy People, a podcast and online content platform for think tank experts.