Running Low on Fuel

Telemus Weekly Market Review August 15th - August 19th, 2022

Stocks lost ground this week with the S&P 500 dipping -1.2% lower. Bonds, as measured by the Bloomberg U.S. Aggregate index, fell -0.9%. After enduring a challenging start to the year, stocks have steadily risen over the past two months, with the S&P 500 now 13% higher than its recent low on June 14th.

The rally in stocks has been supported by a couple of key factors. First, corporate earnings results during the second quarter, while not rosy, were generally in line with expectations. Many market participants were closely listening to what corporate managements were saying and the direction of their guidance. While overall guidance tended to be more cautious, it wasn’t as bad as feared. In addition, bond yields, and the 10-year Treasury in particular, have retreated from peaks set on June 13th. Lower bond yields tend to benefit valuation multiples of stocks, thereby serving as an added contributor to recent surge in share prices.

From the standpoint of underlying market structure, a key influence on the recent rally has been meaningful short covering among hedge funds. Hedge funds often reduce market risk by shorting stocks that they find less desirable. When we look at the stocks that have performed best over the past two months, they have been lower quality companies that had been heavily shorted by hedge funds during the market downturn. As hedge funds ‘covered’ their shorts, or bought the shares, this helped to drive the prices higher on these stocks. In addition to activity among hedge funds, we’ve also seen significant inflows into equity mutual funds and ETFs in recent weeks, with the corresponding buying pressure helping to prop stock prices higher.

This past week we hit a couple of interesting technical indicators. The S&P 500 price level hit an overbought status mid-week. In addition, on Tuesday the S&P 500 reached its 200-day moving average, a key technical measure, before bouncing lower. With selling pressure continuing on Friday, the 200-day moving average may indeed be serving as an upward ceiling for stock prices in the short-term.

As we look ahead, stocks may be headed for a period where stocks hold within a near-term trading range. The next key macroeconomic event will be August’s inflation data, which will be released in mid-September. This will be followed a week later by the next meeting of the Federal Reserve Open Market Committee, where it remains uncertain just how much they will raise rates along with what guidance they will provide around the magnitude and cadence of rate increases over the rest of the year. This will be followed by third quarter earnings reports in October, where a lot of attention will be paid to how companies are posturing around their expectations for earnings in 2023.

The recent rally in stocks has been a welcome respite from the challenging first half of 2022. However, the market factors that have driven the recovery appear to be diminishing, market technicals indicate the rally may be fading, and its hard to justify a notable surge higher until see more consequential information around the economy and corporate earnings.

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