Does This Rally Have Legs?

Leo Wealth

Aleksey Mironenko

Timing short-term market movements is a fool’s errand, so we will not pretend to know the next few weeks ahead. However, with the S&P 500 up 17% since its bottom on June 16 and down less than 10% YTD, it’s hard not to discuss if the rally will continue or if it has gone a little too far too fast. There are strong arguments on both sides, and while we lean toward the “it has legs” camp, it’s useful to lay out both arguments to understand who investors may think.

The “it has legs” view: Investors overall are still overwhelmingly bearish. The regular BoA survey of investors shows a bottoming but not yet a recovery of investor sentiment. In fact, the number of investors who are overweight equities and expecting a stronger economy are still almost as low as 2008 levels (see chart). Long U.S. dollar, long cash, and long healthcare/REITs/utilities (all defensive trades) are the top three trades by investment managers today. Equities overall, Europe/EM and tech specifically, remain the biggest shorts. The more investors remain bearish, the more a rally can run. On the macro front, inflation indicators continue to point to a substantial slowdown in price increases, supporting the thesis that peak Fed hawkishness is behind us. In addition, employment continues to power ahead, allowing consumers to feel confident in spending down savings, thereby driving profits for corporations. Most analysts understand that earnings will come down, and many top-down asset allocators already have bearish expectations, leaving room for an upward surprise in 2H22. Finally, market technicals – retracement bands, moving averages, and breadth measures – all point to the start of a new bull market, as do easier financial conditions and lower credit spreads.


The “sucker’s trade” view: Peak inflation means peak pricing power, which in turn means that Q2 earnings beats are unlikely to be repeated in H2, much less 2023. The Fed may be less hawkish given the data today, but with energy prices dropping, the only sector that kept S&P 500 earnings positive in Q2 is unlikely to do so going forward. In short, earnings expectations will fall further, and that means valuations are no longer reasonable. In addition, a slowdown in inflation does not result in 2% inflation – we’ll probably get to 4-5%, which is still double the Fed’s comfort zone. And even the bulls will acknowledge that financial conditions have eased and quantitative tightening hasn’t started yet.  Easier financial conditions are not what the Fed wants, which means that while the market is pricing an outright decrease in rates in 2023, we may still see a mildly hawkish Fed next year. This is not priced into bonds, much less stocks. Outside the U.S., the macro story is clearly worse. Europe is setting new highs for natural gas prices every day and is very likely to enter recession as they ration energy through winter. China’s property market is past the point of cyclical slowdown, and the country is now in full crisis management mode. With the U.S. and China – the world’s two major growth drivers – on the sidelines for now, what exactly will propel equities higher?

Both camps can make a compelling argument. But as investors, we must form a view, and as mentioned earlier, we lean to the positive interpretation for now. Our main rationale is as follows: 

Growth in the U.S. is stronger than GDP statistics suggest, which means profits will hold up better than expected for the next 1-2 quarters. Investors are still hyper-bearish and skeptical, which means there’s room for bear capitulation and a continued rally if employment, earnings, and inflation data continue their current trend. The Fed doesn’t meet until Sep 28th, leaving room for three inflation, two employment, and multiple spending prints to dictate market direction. Any upside growth or low inflation surprises will likely push markets higher for at least a month or two.


The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to the accuracy, completeness, or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.  There are risks associated with these types of investments and include but are not limited to the following:  Typically no secondary market exists for the security listed above.  Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.  Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.  The offering is made only by the Prospectus.

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