Categories: Markets

The Bear Market Has Nearly Been Erased, Fewer Than 20 Months After It Began

(Bloomberg) — It made sense at the time. Jerome Powell is waging war against inflation. The bond market is flashing dire warnings. Almost everyone saw a recession coming.

And yet less than 20 months after it began, the bear market that engulfed the S&P 500 is only 260 points from a complete wipeout. Rather than forecast trouble, chart patterns tracking everything from cross-asset momentum to transportation companies paint a picture of emerging economic strength.

That some of the signals coming out of the US economy are nowhere near as strong — and that Federal Reserve policymakers are less concerned about inflation now than they have been — is just a distraction for investors pushing stocks for just the eighth time in 10 weeks. If optimism holds, last year’s bear market has an attempt to unravel faster than all but three of its predecessors since World War II.

“I was surprised that the Fed actually took the soft landing and everyone was caught underweight equity exposure,” said Dennis Davitt, co-manager of the MDP Low Volatility Fund which recently adjusted its positions to prepare for further market rises. “As people have to get the right size of their portfolio, they have to go in and buy, and every day it’s harder.”

Nearly $10 trillion has returned to equity values over the past nine months as job growth, consumer spending and corporate earnings defied the doomsayers. Up 27% from the October trough, the S&P 500 is now about 5% from retrieving the all-time high of 4,796.56 reached in January 2022.

If the index completes a round trip in September, it will make a full recovery twice as fast as the average of the previous 12 cycles, data compiled by Bloomberg show.

What began as a rally driven almost entirely by a handful of tech megacaps has turned into a cross-sector surge fueled by fading economic fears. From small caps to energy and banks, economically sensitive sectors are driving the latest move.

While skeptics continue to point to a widely viewed indicator of recession — the inverted yield curve of Treasuries — as a warning that the economy is out of the woods, the equity market is telling a different story.

The latest evidence comes from simultaneous breakouts in transportation and industrial stocks. The Dow Jones Industrial Average rose for 10 straight days, its longest winning streak in six years, while a similar measure tracking airline, railroad and trucking companies rose for four straight weeks. In the process, both hit their highest levels since early last year.

According to followers of a century-old charting method called the Dow Theory that places two groups of signs on future economic growth, the simultaneous strength is a strong sign.

“Momentum has a habit of feeding itself,” said Michael Shaoul, chief executive officer of Marketfield Asset Management. “Where we feel most comfortable is to expand the rally to cover most of the economically sensitive sectors.”

Equities are not the only asset that ignores the alarm from the yield curve. Oil rebounded after a first-half decline, rising back above $75 a barrel, while credit spreads fell to a four-month low.

Whatever scary scenarios investors have in mind heading into 2023, few have panned out so far. While many lenders in the region failed, the government rushed to ring-fence the fall and now the financial results from the big banks have greatly exceeded expectations. The KBW Bank Index jumped more than 6% for its best week in 14 months.

The fundamental strength is forcing economists to rethink their recession calls while prompting Wall Street strategists to raise their year-end price targets for the S&P 500.

Reluctantly or not, the bears gave up, one by one. Computer-driven funds, which short stocks after the 2022 sale, were among the first to resist.

From trend followers to volatility-focused funds, systematic managers acquired a total of $280 billion in global shares in the first half alone, according to an estimate from Morgan Stanley’s sales and trading desk. This week, their net equity leverage, a measure of risk appetite, hit its highest level since early 2020.

After some initial resistance, stock-picking investors began trimming their short positions and adding longs. Hedge funds tracked by Morgan Stanley’s main brokerage unit last week saw their net leverage rise by 50% for the first time since February 2022.

“It’s a market driven by momentum. It’s hard to call when it’s going to stop,” said Jimmy Chang, chief investment officer of the Rockefeller Global Family Office.

Chang is not alone in having a persistent sense of dread. In the latest survey by Bank of America Corp. among money managers, cash holdings increased to 5.3% from 5.1%. Meanwhile, the need for protection prompted an offering of a new exchange-traded fund that seeks to hedge against 100% of stock losses over a two-year period.

Indeed, the list of concerns is long. Estimates are expected. Inflation may stick and the Fed may keep interest rates higher for longer. While it may be delayed, the threat of a recession still remains. And bankruptcy filings are on the rise.

“Markets climb a wall of anxiety, and sometimes, the more issues investors are concerned about, the better the return ahead,” said Paul Hickey, a co-founder of Bespoke Investment Group. “On the contrary, if you think things can’t go wrong for the stock market, you get years like 2022. Complacency kills.”