US bear market rally is in full swing, but how long will it last?
- US stocks have made back much of their losses from the first half of the year, and there are signs that the rally in equity markets still has a way to go
- An examination of factors such as policy, positioning, price and profits might help answer whether we are heading for a bull market, or if the lows will be tested again
Equity rallies during periods of overarching market weakness are not uncommon, and there can be multiple rallies even during a more prolonged downturn. Analysis by J.P. Morgan of the past five major US equities’ bear markets showed that the market rallied by more than 10 per cent on average five times during those bear markets.
So will this rally become a bull market, or will the lows be tested again? Using a framework of four Ps – policy, positioning, price and profits – might help in answering that question.
On positioning, risk sentiment weakened in the first half of the year and investors pulled money from global equity markets. The Bank of America fund manager survey for July reported that a net 44 per cent of asset managers were underweight on equities in their portfolios. The last time the percentage was so high was in October 2008, in the depths of the global financial crisis.
When asset allocators have more cash than usual to put to work in the market, it can sometimes be seen as a contrarian indicator and a positive sign of things to come. To paraphrase Warren Buffett, the best time to be greedy is when others are the most fearful.
The final piece of the puzzle is profit and whether companies can continue to remain profitable in a slowing economy as revenue growth is tempered and margins pressured from rising input costs.
The US second quarter earnings season has just wrapped up, and the news was not good. Corporate earnings fell by 9.5 per cent compared to a year ago and 4.6 per cent between the first and second quarter.
More important for the market was that, with expectations so low heading into the earnings season, it was not a particularly high hurdle for corporate America to overcome. Around 70 per cent of companies were ahead of analysts’ expectations for revenue and 63 per cent beat revenue estimates.
The rally in equity markets since June will be welcomed by many after the horrendous performance in the first half of the year. Having said that, it is not clear whether they have found the bottom or if they will retest their lows at some point.
While the market is likely to remain cautious, given the uncertain economic outlook, a framework that considers policy, position, prices and profits should provide some context to how far the rally can go.
Kerry Craig is a global market strategist at J.P. Morgan Asset Management