Text size
The stock market is rallying. Don’t expect it to continue.
All three major indexes have gained for two straight days. The
S&P 500
rose more than 2% Monday and was up another 1.1% Tuesday afternoon, but it could be only a so-called bear-market rally.
That is when stocks stage a brief—and often large—upswing in the middle of a larger bear market, or decline of at least 20%. On Tuesday, the
S&P 500
was down about 22% from its record closing high, hit in early January.
Behind that slide, of course, is the Federal Reserve’s effort to fight inflation by raising interest rates to cut demand for goods and services. Corporate profits are likely to suffer as the economy slows, while higher rates reduce the current discounted value of earnings that are expected to arrive in coming years.
The S&P 500 is still in an overall downtrend even though it has posted a gain this week. In terms of technical analysis—the craft of predicting where markets will go next based on their past movements—it won’t escape that bearish pattern until it rises above the 3900 area. Once it surpasses that level, the chances that it moves even higher will increase.
The market is currently a bit above 3700, so there is a lot of ground to make up before it reclaims its record high of 4796.
Like many bear-market rallies, the current surge is driven by what could be a temporary burst of buying activity. Investors have sold vast amounts of stock as the market has plunged this year, so they already have large sums of cash to put to work. The average equity fund manger surveyed by
Bank of America
is holding more cash as a percentage of their portfolio than at any point since April 2001.
At the same time, shorting the market—selling borrowed shares in hopes of buying them back at a lower price—has become a popular trade in the past couple of months. In August, market participants were holding hundreds of billions of dollars more in long positions than short positions, according to RBC data.
Since then, short selling has caught up, boosting the amount of cash traders have on hand as they pocket the money paid for their borrowed shares. The total value in shorts versus longs were about even as of early this week.
The result: Market participants started this week holding a lot of cash and relatively little stock. That means many market participants are in a position to buy stock at the same time, especially if they see any hope, even if unfounded, that inflation will decline and the Fed will slow down the pace of its rate increases.
“Equity markets are waking up to the fact that positioning and sentiment is so negative that a bear market rally is upon us,” wrote Natalliance Securities’ Andrew Brenner.
The outlook will improve eventually. But until that happens, expect these mini rallies to end quickly.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com