On 8 June, the S&P 500 index closed above 4,292, marking a 20 per cent rise from October 2022’s low point of 3,577. According to Tom Stevenson, investment director at Fidelity International, this would generally indicate a bull market.
“The measurement of bull markets is more art than science. On plenty of occasions, markets have enjoyed a rally of 20 per cent or more before reverting to their previous downward path,” Mr Stevenson said.
“The stock market bear is a wily beast and enjoys pulling wishful thinkers into its embrace with this kind of sucker’s rally. This time around, there are more reasons than ever to question whether this is the start of a sustainable bull market or another false dawn.”
Chief among these reasons is how narrow the recovery has been since the start of the year.
“The S&P 500 may have risen by 13 per cent since the beginning of the year but almost all of that gain can be attributed to the performance of a handful of the index’s biggest companies, almost exclusively technology stocks which have soared on the back of investors’ new-found enthusiasm for all things artificial intelligence (AI),” Mr Stevenson said.
“The S&P 500 is market capitalisation-weighted, which means that the larger a company is, the more influence it has on the overall level of the index. It is a reasonable way of looking at the market but at times like these, when there is a big divergence between the performance of large and smaller companies and the leadership is so narrowly focused, it can also be misleading.”
He said that if looking at the market through an equal-weighted lens, the year-to-date increase drops from 13 per cent to just 3 per cent. If this is expanded to the market low on 12 October 2022, the rise drops from 21 per cent to a still impressive but much lower 14 per cent.
“So, as the headline index, but not the wider market, moves into bull market territory, investors face two key questions,” Mr Stevenson added.
“First, is the recovery since October the real McCoy or just another bear market rally? Second, if we are at the start of a sustainable bull market, what is the best way of playing it?”
Whether or not the recovery has staying power, according to Mr Stevenson, will broadly depend on corporate earnings, interest rates, and whether the rally broadens beyond “AI-focused tech stocks”.
“The earnings picture is slowly turning more positive. Not so long ago, the expectation was that the economy was heading towards a recession. And that, historically, has led to a double-digit decline in earnings,” he said.
“Today, the consensus is for a much more modest fall in profits, perhaps only 4 per cent in 2023. Better still, next year is expected to deliver an earnings rebound of as much as 10 per cent.
“At the start of the year, only around a quarter of companies were seeing an improvement in their earnings forecasts. Today, half of them are. Less bad is the first stop on the journey to good and this so-called second derivative is clearly heading in the right direction.”
Following the US Federal Reserve’s decision to put its monetary tightening program on hold, Mr Stevenson said the interest rate question “looks to have a broadly positive answer”, even with another hike on the cards for July.
“The third question, on the breadth of the recovery, is the clue to how best to play the next phase of the cycle,” he said.
“For the bull market to be really sustainable it will need to broaden out from the tech stock leadership that has been the defining characteristic of the past six months. And there are early signs that this is happening.”
Mr Stevenson added that more investors are positive than negative on the market’s prospects, however cautioned that there was another hurdle to clear.
“Typically, bear market rallies run out of steam at or below the point where they have retraced 50 per cent of their most recent fall. A rally that breaks through this barrier usually goes on to become a sustainable bull market,” he said.
“Here the evidence is mixed. The S&P 500 index has clawed back 63 per cent of what it lost in 2022. But the equal weighted index is only 39 per cent of the way there.
“That suggests one of two things. Either this is a bear market rally that has overstayed its welcome and the technology leaders might be hardest hit in the correction. Or the bull really does have legs, and the rest of the market has some catching up to do.”