A Stock Market Rally Is Still Possible for the End of 2022, if These 5 Things Go Well.
All it would take is for one of the five to go in the right direction to have a snowball effect afterwards.
Now that the Bear Market has taken over the stock market, investors have only one question on their minds: how long will this Bear Market last? The analysis of previous Bear Markets clearly shows that there is no precise rule on how long this market will last.
This market decline is all the more complicated to live with as investors have just experienced the worst first half of the year since 1970, with a drop of over 20% on the S&P 500.
A note from Ned Davis Research (NDR) attempts to answer the question: “Extremely weak first halves are almost always followed by strong second halves,” says Ed Clissold of NDR. “A second-half recovery would require improvements in inflation, the Fed, the economy, geopolitics, and earnings.”
For those elements to happen with a snap of the fingers would be nothing short of a miracle.
Since the beginning of the year, the market and investors have already suffered many setbacks. One piece of good news could have a snowball effect on the markets and get things moving again. So here are the five things that NDR believes could be that boost, and how they would work.
1. A drop in inflation in America
“A few signs of improvement on the inflation front could be enough to spark a rally in stocks. The consumer price index has been accelerating since June 2020. If it moves below its six-month moving average, it could mean the worst of the inflation is over,” Clissold says.
For May 2022, for example, inflation was 8.6% in the US, compared to a six-month moving average of 8.0%. The latest official estimates expect it to fall to 5.7% by the end of 2022. Thus, if the interest rate hike takes effect and manages to calm inflation, we could already see a recovery in the stock market.
The figure for June 2022, published in mid-July 2022, will therefore already be an interesting indicator.
2. The bond yield curve
For some, including Clissold, the Fed will do everything it can to curb inflation, even if it means a recession. But a recession is not a good climate for the investment world.
The report notes that one should look at the three-month bond yield curve and compare it to longer-term bond yield curves. If the yield on three-month bonds becomes higher than the yield on five-year bonds, for example, it is generally seen as a sign, almost infallible, of recession.
In other words, it means that short-term lending is becoming riskier than long-term lending when usually the opposite is true: long-term lending is riskier because events that can happen are less predictable than short-term events. Other comparisons are also often used as indicators, such as the two-year bond yield versus the ten-year bond yield.
In short, the report indicates that if the bond yield remains higher, on an ongoing basis, this is an indication that the Fed will not achieve a “soft landing”. So it also means that, on the contrary, if the curves do not invert or remain inverted, the chances for a soft landing are higher, which would be a good signal for the market.
3. America avoids recession
Clissold also dives into the bear market and recession data:
“The average bear market without a recession is a 25% drop over 9.1 months, compared to 34.6% over 15.3 months for bear markets with recessions. Over the past 50 years, the median bear market without a recession has fallen 18% over 6.8 months. If the economy avoids a recession, then the current decline is approaching the median decline in both duration and price.”
The S&P500, like the European stock indexes, has been down for six months since the beginning of 2022, so there is a sign of hope for a recovery. But it's also important to keep in mind that this is average.
4. Midterms Elections in America
Geopolitics also plays a role in a potential market recovery. Of course, an end to the conflict in Ukraine would have a very positive effect on the various stock markets. But American politics also has an influence: this year, in November 2022, the Midterms in America will take place. This is bad news for the market because the third quarters of these election years are usually synonymous with bad results, the report shows.
The bad news may be the good news: “The presidential party tends to lose seats in both the House and Senate, especially in the president's first term. The good news for those expecting an uptick is that historically, inflation-adjusted returns have been higher when Democratic presidents have enjoyed some congressional control over their power,” Clissold nuances.
Following the logic of these averages, the stock market should therefore rally after the results are counted.
5. Corporate profits
An important part of stock values is the earnings and other financial results of companies. As such, they can also be the trigger for recovery (or a further decline, depending).
“Year-over-year comparisons almost guaranteed that earnings growth would slow in 2022. It was a matter of degree ... How companies control employee costs could determine whether second-half earnings revisions are benign in nature or a harbinger of an earnings recession,” Clissold analyzes.
We are at the end of the second quarter, so we can expect corporate earnings announcements in the coming weeks. These results will already be an interesting indicator of the state of the market.
Nothing is guaranteed as always, but this should help you to keep a little hope in the current painful market, and above all, not to give in to the gloom. Because these periods, however difficult they may be, always come to an end. It is only a matter of time.
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