The market's historic mini rally faces three big tests

Can we really see the equity base?

Rubner certainly sees signs of resilience, not least of which is that for all the pain investors have endured this year, they have continued to hold on to their shares, with small equity outflows this year far from the investor capitulation that has historically signaled the end of a bear market.

That the rally on Wall Street was not derailed by the strong US employment data released late Friday also shows fresh signs of resilience.

Indeed, the idea that bad news is good news – that is, strong economic data supporting a further round of aggressive central bank rate hikes is actually positive because it will bring about a recession that will see the Federal Reserve start easing monetary policy again – seems to be gaining some acceptance. .

The shift from cyclical stocks that will succeed in an inflationary environment towards stocks that win when inflation is low or even falling speaks for itself.

Bank of America data showed material stocks on Wall Street posted their biggest outflows last week, while resource stocks sold for three weeks and financials (which also won when interest rates rose) have sold for the 15th week in a row. Weaker tech stocks, on the other hand, have reported inflows for the fourth week in a row.

Eyes on Wednesday night

Of course, the narrative that inflation has peaked and the central bank could cut interest rates next year will come under a major test this week when US inflation data is released late Wednesday.

The market knows the numbers will be huge. Citi forecasts headline inflation month-on-month running at 1.2 percent, which would put the annual rate around 8.9 percent and set the stage for the Fed to raise interest rates by 0.75 percent at its July meeting.

That’s probably the entry price. But beyond that, investors are grappling with the question of whether signs of cooling inflation in goods prices (computer chips, used cars, commodity prices and shipping rates are examples) and cracks in the resilience of the economy (falling consumer confidence and an index of manufacturing activity) convince the Fed that it can stop its cycle of rising interest rates.

If so, the mini-rally of the last few weeks could gain a bit more momentum.

But this will not be an easy test to pass. Citi doubts whether the Fed in full inflation-fighting mode will get the strong evidence needed to show that inflation is getting back under control or that previous rate hikes have caused major damage to the US economy which, despite the exhaustion, will persist. expansion mode for the rest of the year.

Citi expects the super-large rate hikes in July to be followed by 50 basis points in September and November, and 25 basis points in January and March.

His forecast for the Fed’s terminal rate was at 4 percent to 4.25 percent, well above the bond market’s forecast of 3.3 percent.

Bank of America Uber-bear Michael Hartnett said the current rally could last for several months, but “it’s not over until the Fed lady sings”.

“A bear market ends with a recession or an event that causes the Fed to reverse policy. We’re saying the bear market is on a summer lull… and the ‘big low’ hasn’t been reached.”

China and US Revenue

Two other tests for the market’s mini rally are in sight this week.

The next most important comes from China, where a plethora of data points will be released, including trade figures, credit data, fiscal income and expenditure figures and, most importantly, GDP growth on Friday.

China’s 5.5 percent growth target for calendar 2022 seems nearly impossible amid reports of the new COVID-19 outbreak. Friday’s data is expected to show economic growth of 1 percent in the June quarter versus a year ago, but the big focus on Friday will be on signs the economy is starting to recover from lockdowns in June.

Friday also brings a decision on China’s official interest rate. While most economists expect interest rates to remain on hold, data at the weekend showed inflation rose 2.5 percent month-on-month in June thanks to rising pork prices, which has raised concerns that it will be more difficult for China to cut interest rates and stimulate economic growth. economic growth. economy.

The third test for investors is the US earnings season starting this week. Most in the market believe earnings forecasts look upbeat in the face of high inflation and a slowing global economy, and a downgrade in earnings could trigger a new wave of selling.

Does that downgrade cycle start this week? Or is the resilience of the US economy shining? There are lots of things to play with.

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