Why the Dow has finally bounced back—and what it takes to prove it’s real

A little pre-summer cheer finally made its way to the stock market in the week leading up to Memorial Day, but it will likely take more than a week for the Dow Jones Industrial Average’s first win since late March to convince nagging investors that pain is in the past.

what happened? Real or inflation-adjusted interest rates have fallen over the past week, corporate credit spreads — the yield premium on US Treasuries that investors require to buy corporate bonds — have tightened and investor expectations of future Fed rate increases have waned, noted Mahmoud Noorani, CEO. Research firm Quant Insight, in an interview (see chart below).

quantitative insight

This gave some breathing space for the jump. The Quant Insight model showed that the S&P 500 had fallen below fair value but is now aligned with the scale.

S&P 500 SPX Index,
+ 2.47%
It had successfully avoided a close in bear market territory on May 19 after hitting a session low of more than 20% below the level set on Jan 1. 3 close records. It then rose 6.6% over the past week, ending Friday 13.3% below its early January peak as it snapped a streak of seven consecutive weekly declines.

Nasdaq Composite,
+ 3.33%And the
Still solidly in bear market territory, it also broke a series of seven weekly declines, up by 6.8%. Dow Jones DJA,
+ 1.76%
The corresponding rise of 6.8% marks the end of eight lost weeks, the longest since 1932.

Kevin Dempter, analyst at Renaissance Macro Research, also pointed to a host of positive factors, including a significant pullback in the US dollar, severely oversold technical conditions, and very bearish sentiment, while some stocks, such as Nvidia Corp. NVDA,
+ 5.38%And the
It managed to reverse the upside despite the bad news.

Opinion: S&P 500 may find short-term bottom – but medium concerns remain

However, neither Noorani nor Dempter was ready to get to the bottom of the market. There was no shortage of outright bearish forecasts. Michael Perry, founder of Scion Asset Management, rose to fame after predicting the US housing market crash as reported in Michael Lewis’ book “The Big Short”, in a since-deleted tweet that included parallels with the 2008 market crash. .

In a new tweet on Friday, he talked about the prospects for a consumer-led recession:

This reflects concerns raised earlier in May as retailers targeted TGT,
+2.41%
and Walmart WMT,
+ 1.97%
Disappointing earnings were reported, deepening the stock market sell-off amid concerns that inflationary pressures are starting to weigh on corporate earnings.

Noorani said the additional decline in real returns could allow stocks to rise further in the near term, but said that returns are not likely to have peaked.

After all, while the data, including Friday’s reading of the core personal consumption expenditures index, the Fed’s favorite inflation indicator, shows inflation is slowing, the task of bringing price pressures back under control is far from over, he said.

This leaves uncertainty about how high the fed funds rate, currently at 0.75% to 1%, will eventually rise. He noted that the market rate refers to the so-called final interest rate between 2.5% and 3%, but anything that indicates that it will be higher than that will cause investors to worry.

He said the single most important factor for yields “will be Fed policy,” noting that central bankers “are horrified by inflation at these historically high numbers.” Even if it hurts the real economy, “they have to hit the brakes really hard and bring those numbers down.”

While the S&P 500 has not technically confirmed that it is in a bear market, many market watchers see it as a mere formality, noting that stocks were showing bear-like behavior for most of the sell-off in 2022.

Dempter, in a note on Friday, downplayed the sharp outperformance of the consumer discretionary segment for the rest of the market in the previous session, acknowledging that, historically, discretion has seen a sharp improvement in relative performance about a month before lower growth. The move was more likely an oversold bounce than a bottom, he said, explaining that RenMac would be more optimistic “if growth is weaker, inflation has peaked.”

“History suggests that both growth and inflation need to weaken further before bottoming can occur,” he said, noting that the energy sector’s continued outperformance in healthcare suggests that inflation has not yet peaked.

Read more: This Stock Market Index Suggests Investors Don’t Think Inflation Has Peaked: Analyst

“We will be watching ISM next week [manufacturing index] Number, as a weak reading could shift the market cycle clock closer to an area more favorable to the bottom.”

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