Bear Market Rally
The S&P 500 and Nasdaq both rose over 6% this past trading week, which broke a seven-week losing streak. We would classify the positive momentum as more of a bear market rally than the beginnings of the next bull market. A bear market rally or relief rally is a short-term sharp recovery in the stock market amid a longer-term market drawdown. These volatile swings in both directions are typical during market crashes, as equities generally do not fall in a straight line.
Investors have questioned whether the most recent economic data led to the market boost. The April inflation reading came out this week and eased a bit from the prior month but remains elevated, and we do not expect further relief in May. And, while consumer spending data released Friday indicated another month-over-month increase for the 4th straight month, it was largely funded through household savings which dipped to a 14-year low. The Fed minutes from the May meeting were in line with expectations as officials announced plans to raise interest rates by 0.5% in June and July.
Our research suggests that much of the positive price action is likely attributable to hedge funds covering their short positions, which causes short-term price support but is not indicative of a sustained recovery. Looking back to the Global Financial Crisis from 2007 to 2009, markets experienced eight meaningful rallies during an 18-month period. Of the eight, three of the rallies were extensive and lasted between 6 and 8 weeks, and the gains during these brief recoveries were each at least 6.5% while two gained over 18%. But, as you can see in the first chart below of the S&P 500, buying the dips during these short upswings resulted in significant losses as the selloff deepened.
The second graphic below illustrates 3-month, 6-month, and 12-month returns in the S&P 500 following weeks in which markets gained at least 6%. In general, strong weeks have led to market strength; however, many of these periods benefited from Dovish Fed policy, which for now remains unlikely. The current environment may most closely parallel the market in 1974, a period which was marred by high inflation and a Fed regime committed to rising interest rates that ultimately resulted in a deepening recession. As history suggests, markets have usually fared well 12 months out, but outcomes are largely contingent on cooperative Fed policy.
In our view, the primary fundamental factors that have caused the steep market decline have not changed. For now, the Fed remains committed to tightening monetary policy, inflation is elevated, and the economy is continuing to show signs of weakness pointing to a recession.
This week, we added a short position on high yield bonds. The high yield market is showing signs of pressure and higher interest rates and slowing growth should only exacerbate issues in the market. Master Limited Partnerships (MLPs) were also added to portfolios. MLPs primarily facilitate the transportation of oil and natural gas. These investments pay a nice dividend and generally perform well in bullish energy markets.
We are committed to keeping our clients informed during these turbulent times and will notify you as our outlook evolves.
Lincoln Sorensen, Family Wealth Advisor & Co-Founder