Market Update - Last of the summer wine?

Wednesday 24 August, 2022

In summary

• The summer rally has seen the S&P 500 up 16% to Friday 19th August

• A potential Fed ‘pivot’ ignited the rally

• A well-diversified portfolio remains fundamental to navigating market volatility

Market bounces

The summer months have seen some buoyancy return to global stock markets. This has been a welcome relief for investors after a torrid first half of the year, with both bonds and equities posting unprecedented losses. The S&P 500 had its worst H1 since 1962 but is up around 16% to last Friday since its 52-week low on 16^th June, the day after the Federal Reserve (Fed) raised interest rates by 0.75%^[1]. The question now for investors, is whether this is a typical bear market rally or a bullish reversal and the beginning of a new bull market phase. 

The numbers

The following table highlights the breadth and scale of the market rally we have witnessed since 16^th June. To further this point, 85% of companies in the S&P 500 are in positive territory, with an average return of 8%^[2].

 

16 June ‘22 –  19 August ‘22	IA Sectors	%
Top five	IA North American Smaller Companies	21.18
	IA Healthcare	18.93
	IA North America	18.68
	IA Technology	18.30
	IA Financial & Financial Innovation	16.02
Bottom five	IA UK Equity Income	5.58
	IA Global EM	4.06
	IA Asia Pacific ex Japan	3.79
	IA UK Smaller Companies	2.77
	IA China	-1.65

Source: FE Analytics

 

Sectors that have fared the worst until mid-June have generally been the best performers since then, suggesting a sign of mean reversion. The summer rally has been driven mainly by the US, and more specifically US tech companies. To illustrate this point, from mid-June until last Friday, Apple is up +32%, Amazon +33%, Microsoft +17% and Tesla +39%^[3]. As of Friday 19th August 2022, the US tech orientated NASDAQ 100 was up 19%^[4]. However, it is important to have some perspective on this recent upswing. Whilst MS US Advantage (another US tech orientated fund) is up +34% since 16^th June, from the start of the year until that date, the fund was down -50%^[5].  

New bull market?

This recent rally was initially ignited following the June Fed meeting as talk of a potential Fed ‘pivot’ began to gather steam. Such a pivot is viewed as good news for the longer duration US tech stocks that have rallied hard since mid-June, as it would imply that the path of aggressive interest rate rising is likely to be more accommodative than the market previously expected. Chair Powell will speak this Friday following the Jackson Hole Symposium, having not spoken publicly since the end of July, and investors are likely to be scrutinising his every word given the small amount of evidence that inflation appears to perhaps be rolling over. 

Thin trading volumes during the summer earnings season historically tends to lead to a tough market for equities over the summer months. This time around, the landscape has been different, perhaps due to short sellers covering their positions, but also because retail investors have used the market rally to put money back into markets^[6].

Whilst one data point doesn’t make a trend, we may have passed peak bearishness in mid-June, and whilst US inflation is at the same level it was back in April, it is the direction of travel that is core to how markets assess risk. We don’t expect the extraordinary rally to continue from here, and a number of external risk factors remain in the frame. Although, we could see continued market support for a slowing Fed or potential cut in interest rates from next year in the US. 

 Bear market rally?

One reason for markets to take another leg down could be evidence that US inflation is stickier and more entrenched. This could lead to a wage price spiral and so the Fed may be forced to continue hiking rates aggressively to bring inflation figures back to their desired 2%. The price pressures will soon start filtering through to companies, eroding corporate margins. We will be looking out for this during the Q3 earnings season. 

Even if the Fed is ‘successful’ in tackling inflation, there are a number of other macro and market risks on the horizon. These include the challenges around China’s slowing growth rate and potential advances across the South China Sea, US midterms in November and Eurozone instability, to name a few. On our shores, we had the recent warning from Citi that UK inflation could peak at 18.6% in January 2023 fuelled by rising energy prices^[7].    

Concluding thoughts

Purely considering backward looking market data, the last couple of months have mirrored a number of previous bear market rallies including the Great Financial Crisis, dotcom bust, and the 1973 bear market. These were all followed by further falls of between 20% and 45%^[8]. However, similar analysis could be produced for periods where markets continued upwards following a sharp correction. The more the talk of a ‘bear market rally’ in the financial press, the less emphasis one tends to place on such eventualities.  

Now more than ever demonstrates the importance of a well-diversified portfolio. Right now, that looks like a healthy allocation to cash and absolute return funds, as well as high quality bonds and equities. Volatility is likely to continue throughout the remainder of the year, as market direction continues to be driven by the release of macro data and comments from central bankers. Markets can turn quickly so an active and dynamic approach to both asset allocation and investment selection remains crucial. 

[1] Factset

[2] Factset as at 19.08.22

[3] Factset as at 19.08.22

[4] Factset

[5] Factset

[6] Morgan Stanley QDS, Exchange Data Feeds

[7] https://www.reuters.com/world/uk/uk-inflation-hit-18-early-2023-citi-forecasts-2022-08-22/

[8] Factset

Please note: The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

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