The recent recovery in equity markets is most likely an example of a rally in a bear market rather than a sign of the market turning, according to boutique fund manager, Talaria Capital.
Two key signals monitored by the firm have yet to indicate that a durable bottom in equity markets is imminent, Talaria Capital co-CIO Hugh Selby-Smith said in a recent note.
“The first is when leading economic indicators trough, allowing investors to anticipate a recovery in the economy and corporate earnings. However at this stage, there is no sign of this happening until at least the second half of 2023,” he explained.
“The second signal is central banks changing to policies that support capital markets. But their first priority is controlling inflation so again, this seems some way off.
“Every market bottom since 1950 has occurred within a month of one or both of these signals. In the meantime, investors need to take steps to protect capital.”
Mr Selby-Smith suggested that investors should be positioning their portfolios to withstand a range of market conditions.
Rallies like the one seen recently, he said, are typical during the course of bear market declines and investors should be wary of interpreting them as being sustainable.
“But I have also been around long enough to know that anything can happen. In which case, I would encourage investors to build a portfolio that is robust in dealing with a range of outcomes,” Mr Selby-Smith added.
He said that recent share price gains had been driven by the view that the Fed may have turned dovish along with a lack of negative surprises in the latest US earnings season, but urged investors to turn their attention to future earnings.
“The market has rallied in the face of an increasingly poor earnings outlook as bond yields have retreated. It appears market participants are convinced that the half-point fall from the highest core inflation in 40 years, currently at 5.9 per cent, will encourage the Fed to ‘pivot’ to lower rates in no time,” said Mr Selby-Smith.
“Yet, when core inflation is above 2.5 per cent and the Federal Funds rate has been lower, the Fed has never shifted to easing unless a recession has pushed the unemployment rate toward 6 per cent or higher.”
“We would be unsurprised if the recent rally should prove short-lived, as we believe there is still some way to go in the current bear market.”
Locally, the benchmark S&P/ASX 200 index returned 5.75 per cent in July alone, according to data from S&P Dow Jones Indices.
