eBusiness Weekly
With the S&P 500 having rallied over 20 percent since its October lows, a number arbitrarily chosen to indicate a bull market, many are wondering whether the bear market is over. While there is a case to be made on both sides of the argument, below we will dive into a few reasons why we believe this to be no more than a bear market rally.
In our view, this rally is not sustainable due to the following reasons:
1. Market breadth is narrow
A narrative rarely discussed by the mainstream media is that of market breadth. Market breadth refers to the extent or range of participation in a stock market or index. The current rally in the S&P 500 has exhibited very narrow market breadth, with a handful of big technology stocks (FAANG + MNT) driving the index higher.
This raises concerns because it indicates that the upward movement is not supported by widespread, healthy participation from a variety of stocks. Below, we present a chart from Bianco Research, LLC showing the performance of the S&P 500 (blue), FAANG + MNT (orange), and the S&P 500 excluding FAANG + MNT (red).
As you can see above, the performance of the S&P 500 since the October lows has been largely influenced by the eight stocks included in FAANG + MNT. However, when these stocks are excluded, the index shows a decline.
While this doesn’t guarantee an immediate reversal in the market, it does highlight potential vulnerabilities and increased risk. If the market breadth continues to remain narrow over an extended period, it raises the likelihood of a correction or a broader market decline.
2. A looming recession and earnings slide
Many have been predicting a recession for nearly a year now, including ourselves, but it has not materialised yet. Our belief persists that the Federal Reserve’s rapid rate hikes, the fastest in four decades, will lead to a significant slowdown in growth, albeit with a lag.
While we can’t cover the full range of economic indicators in this article, it has been evident for months now that there is a marked slowdown in manufacturing activity in the US economy (and most other developed economies) as consumer demand continues to shift from goods to services. This shift, together with a resilient labour market, has underpinned the resilience of the services sector.
However, although services activity is still expanding, it is also starting to experience a loss of momentum.
As hinted at above, the strong pocket in the economy has been the labour market, which remains incredibly tight, with 1,79 jobs per unemployed individual. While a tight labour market may keep the services sector and other pockets of the economy afloat for a while, we ultimately believe that the numbers will turn.
This is particularly true when considering that the labour market typically succumbs to recessionary pressures at a later stage compared to other parts of the economy.
The unemployment rate still remains low; however, average weekly hours have been decreasing. This is understandable, as companies first attempt to reduce costs by cutting hours before resorting to layoffs.
Furthermore, the three-month moving average of non-farm payrolls is also showing a downward trend, indicating a slowdown in the labour market.
If the labour market, as we anticipate, starts to falter, we would expect to witness a decline in consumer sentiment, at which time it would be widely known that recessionary pressures are building up, which will inevitably exert downward pressure on corporate earnings and the stock market as a whole.
3. Liquidity crunch
Finally, we believe that the lifting of the debt ceiling and subsequent issuance of additional Treasuries will result in a net drain on liquidity.
When the US reached the debt ceiling, they were compelled to deplete the balance in the Treasury General Account (TGA), which essentially functions as the US government’s bank account, as they could no longer issue Treasuries to meet their obligations.
Now that the debt ceiling has been raised, they must replenish the TGA by issuing more Treasuries.
This issuance of additional Treasuries has the potential to drain liquidity from the financial system as it redirects funds that could have been invested in stocks or other risky assets and instead holds them at the Federal Reserve (Fed).
Concurrently, the Fed is still implementing its quantitative tightening programme, which further depletes liquidity as its balance sheet (BS) is reduced. This dynamic involves multiple factors and will become increasingly significant in the coming months.
In conclusion, despite the recent rally in the equity markets, there are reasons to believe that it is merely a bear market rally rather than the beginning of a new bull market.
The narrow market breadth, with the performance driven by a handful of stocks, raises concerns about the sustainability of the upward movement. Furthermore, there are indications of a looming recession which will further hurt equities as earnings contract further.
This, coupled with a potential drain in liquidity following the issuance of additional Treasury bonds, could lead the market lower in the months ahead.
While nothing is certain, when considering the above factors, it is prudent to exercise caution and be aware of the potential vulnerabilities and risks in the current market environment. — Moneyweb
