Is this a bear market rally?

Last week saw US stocks post their best week since November 2020, this led some market commentators to call the end of the bear market. The question now is, will there be blue skies ahead for risk appetite, or will markets continue to tremble after a brief respite?

To answer this question, we need to look at three things: 1, what bear markets and bear market rallies look like. 2, What the Fed does next and 3, where the dollar goes in the future.

1, What bear markets and bear market rallies look like

At Minerva Analysis, we continue to believe that we are in a bear market. This is because inflation is sky-high, with little sign of returning to central bank targets anytime soon. It is also because the Federal Reserve and other major central banks will have to keep tightening monetary policy to bring inflation under control. All of the factors that weighed on stocks back at the peak of the bear market a few weeks ago continue to exist, bar one or two. For example, the war in Ukraine continues to weigh on commodity prices, and a barrel of Brent crude oil remains frighteningly close to $120 per barrel. Although China has eased its covid lockdowns, this could still cause havoc to global supply chains, and the risk of further lockdowns remain because of China’s zero covid policy. Thus, there are still many reasons to be fearful if you are a bull in the current economic cycle.

Bear market rallies tend to last for a few weeks; thus, we could see stocks continue to rally this week and next, yet we could still be in bear market territory. In these markets, prior support becomes resistance, so understanding your technical levels is important. For the battered S&P 500 this includes the weekly Exponential moving average at 4193, then the 10-day simple moving average at 4258. As long as the S&P 500 remains above the 100-day simple moving average at 4070, then the bear market rally could be in place. If we drop below this level at any stage, then the bear market is back.

It is worth noting that a bear market typically lasts around 9 months, so there could be some more pain to come for the S&P 500, which only started it sell off at the start of the year. This is another reason why we would only suggest taking short term long positions if you would like to trade through this bear market rally. The big risk for bulls in a bear market rally is that the function of the rally is to change market sentiment to draw more capital into stock markets and other risky assets, only to sell them when stocks rise to a certain level. This is why understanding key technical levels like the ones above, are important in the current environment. Bear market rallies can be tricky, so make sure that you use risk management skills when trading in the coming weeks.

2, The Fed

As we mention above, the stance of the Federal Reserve is unchanged. They have not recently agreed to allow inflation to run rampant, so they continue to add to the risks that the bear market will return. The Federal Reserve is still touting the prospect of hiking US interest rates beyond the neutral rate, which is arguably more of a concern for the economy than a couple of one-off 75bp rate hikes that were dismissed at the last Fed meeting. We have said from the start of the Fed’s hiking cycle that the biggest threat to the market would be a prolonged rate hiking cycle from the Fed. We would have preferred a series of large rate hikes throughout 2022 to nip inflation in the bud once and for all. While the Fed has embarked on a rate hiking cycle, it has dragged its feet on shrinking its balance sheet, yet it remains steadfast in its hawkish message that it will thwart inflation. For now, the Fed continues to say that it will pause if there are signs of economic pressure, however, if inflation only falls to the 5-6% mark as we expect, then we could see the Fed press on with rate hikes and the economy be damned!

3, The dollar

The dollar and risk sentiment/ stock market performance have been moving inversely during this economic cycle. Thus, as stocks have sold off, the dollar has rallied. However, as the bear market rally takes off, we have seen the dollar come off the boil and the dollar index has fallen from its high above 104 to 101.60 on Monday. This sharp selloff has sent short term technical signals for the greenback into bearish territory, but beware, this could just be a short-term move. As we mention above, if you want to know where stocks go next, take a look at the dollar. If the dollar starts to recover any time soon, then it could be a sign that stocks will sell off.