Why the Dow Jones finally rebounded – and what it’ll take to convince investors it’s for real

A bit of pre-summer cheer finally filtered its way to the stock market the previous week Remembrance Daybut it will likely take more than the Dow Jones Industrial Average’s first winning week since late March to convince shaken investors that the pain is over.

What happened? Real, or inflation-adjusted, interest rates have fallen over the past week as corporate credit spreads – the yield premium over US Treasuries demanded by investors to buy issued bonds by companies – have tightened and investor expectations for future Federal Reserve rate hikes have moderated, noted Mahmood Noorani, managing director of research firm Quant Insight, in an interview (see chart below). ).

Quantitative overview

This gave some leeway to bounce back. Quant Insight’s model showed that the S&P 500 had fallen below fair value, but is now in line with the metric.

The S&P 500
SPX,
+2.47%

had narrowly avoided a close in bearish territory on May 19 after hitting a session low of more than 20% below its record close on January 3. It then rose 6.6% over the past week, ending Friday 13.3% below its early January high as it broke a streak of seven consecutive weekly declines.

The Nasdaq Composite
COMP,
+3.33%
,
which remains solidly in bearish territory, also broke a streak of seven weekly declines, up 6.8%. The Dow’s
DJIA,
+1.76%

the corresponding 6.8% rise marked the end of an eight-week losing streak, the longest since 1932.

Kevin Dempter, analyst at Renaissance Macro Research, also pointed to a handful of positive factors, including a sharp decline in the US dollar, deeply oversold technical conditions and extremely bearish sentiment, while some stocks, such as Nvidia Corp.
NVDA,
+5.38%
,
managed to reverse to the upside despite bad news.

Opinion: S&P 500 May Find Near-Term Bottom, But Intermediate Concerns Remain

Neither Noorani nor Dempter were ready to call a market bottom, however. And there was no shortage of downright bearish expectations. Michael Burry, the founder of Scion Asset Management, rose to fame after anticipating the collapse of the US housing market as chronicled in Michael Lewis’s book ‘The Big Short’, in a since-deleted tweet. implicit parallels with the market collapse in 2008.

In a new Friday tweet, he spoke about the prospects of a consumer-driven recession:

This echoes fears that were raised earlier in May as Target retailers
TGT,
+2.41%

and Wal-Mart
WMT,
+1.97%

announced disappointing earnings, triggering an intensification of the equity market selloff on fears that inflationary pressures could start to affect corporate results.

A further pullback in real yields could allow stocks to rise further in the near term, Noorani said, but argued that yields were unlikely to have peaked.

After all, while data, including Friday reading of the Core Personal Consumption Expenditure Indexthe Fed’s favorite inflation gauge, shows that inflation is slowing, the job of controlling price pressures is far from done, he argued.

This leaves uncertainty about where the federal funds rate, currently 0.75% to 1%, will eventually reach. Market prices point to a so-called terminal rate between 2.5% and 3%, but anything that suggests it will be higher than that will rattle investors, he said.

The most important driver for yields “is going to be Fed policy,” he said, observing that central bankers “have been spooked by inflation at these historically high numbers.” Even if it’s painful for the real economy, “they have to brake pretty hard and bring those numbers down.”

Although the S&P 500 has not technically confirmed that it is in a bear market, many market watchers consider this a mere formality, observing that stocks exhibited bearish behavior during much of the sell-off. of 2022.

Dempter, in a Friday note, downplayed the Consumer Discretionary sector’s strong outperformance relative to the rest of the market in the previous session, acknowledging that historically the Discretionary sector sees a strong improvement in relative performance around a month ago. before growth troughs. The move was likely an oversold bounce rather than a bottom, he argued, explaining that RenMac would be more bullish “if growth were weaker and inflation peaked.”

“History suggests that growth and inflation need to weaken further before a bottom occurs,” he said, noting that the energy sector’s continued outperformance relative to healthcare Health suggests that inflation has not yet peaked.

Read more: This stock market indicator shows investors don’t think inflation has peaked: analyst

“We’ll be watching next week’s ISM [manufacturing index] number, as a weak reading can move the market cycle clock closer to a more favorable area for a bottom,” he said.

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