In the past three weeks the stock market has rallied from recent lows, in the context of extreme bearish sentiment. Not unlike the rallies we saw at the beginning of the second quarter and during August the expectation is that we now enjoy a bear market rally into the end of this year.
There are several factors to support this. First positioning is extremely bearish not just in the stock market where hedge funds are holding record short levels of futures but also in the options market where a great number of put option positions have been accumulated.
Behind this a number of risk appetite indicators are still in very risk averse territory suggesting that on balance many investors are positioned for bad news. What is interesting here is that the stock market and the bond market have effectively stopped reacting to bad news.
The earnings season has been a case in point both Amazon
This suggests that the stock market is moving on from some of the concerns it had earlier this year, also with inflation still high there are signs that bond yields are coming in from the extreme high levels of the past couple of weeks – the 10 year bond is now close to the 4% level, a level that’s still painful for stocks, but it has arguably hit a recent high.
Importantly the dollar has softened and in many cases this year currency markets have prefigured stress across other asset classes so the case is building for a bear market rally into the end of the year. Seasonally also November December tend to be quite a strong periods for the stock market particularly in the case of bull markets – which however this is not.
There’s a number of other factors to consider this week we have the Fed meeting there were expectations of a Fed pivot or even a pause that they’ll do a 50 basis point rise in interest rates and then stop and watch as the data comes in and a lot of cyclical data has been softening suggesting that the economy is beginning to slow and the Fed can expect this to have a downward pressure on consumer and service prices.
In terms of market action the most likely factor is that volatility comes down for the time being and this will hurt a lot of people playing in the options market – a lot of people who’ve hedged and in turn it may have a technical upward pressure on the stock market and it would be no surprise for me to see the S&P index trade up to and maybe a little bit beyond the 4000 level.
What does worry me looking out over the next six months is that in the context of a lot of geopolitical stress and growing damage to economy – not just in Europe where Germany is suffering but many emerging markets from Turkey to some across Asia Latin America the housing market in the US is that in the beginning of next year we go into a form of a credit crisis where huge levels of accumulated debt on country balance sheets company balance sheets and consumer balance sheets are troubled by the catalyst of high inflation and high interest rates and this in its own way produces a deeper economic and financial crisis and then we get some real volatility.
Read More: Will The Fed Push The S&P 500 Over 4000?