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New Bull Market or Bear Market Rally?

October was a very strong month for most US stocks and November has continued strong so far. It’s nice to be able to report positive returns for our funds and models after a rough September.

Gains have not been uniform, however. Big Tech continued to feel the pressure of higher interest rates and the bond market also proved it’s not quite as ready to deliver as some recent prognostications would imply.

Now we face the question: Is it sustainable?

Recent economic numbers point to an economy that is proving to be resilient despite the heavy burden of rapidly rising interest rates. However, resilience doesn’t mean strong across the board. The Fed hikes are now starting to hit the workforce, especially in the tech sector and we expect employment number to soften in the months ahead. Keep in mind; this is what the Fed needs to see before they will consider a policy “pivot.” Disappointing earnings reports and/or guidance from the tech sector are further proof that Fed policy is starting to achieve its intended results.

The bond market is developing as a more attractive alternative to stocks. The reason is because the Fed has not yet given a clear indication that it’s ready to slow down and adopt a wait-and see stance. Sure, there have been rumblings from some Fed participants about the risk of “overdoing.” But with another recent 75 basis points increase, and not a lot of proof that inflation is declining materially, there continues to be pressure on interest rates across all maturities.

Convincing proof of declining inflation is needed by both stocks and bonds to prompt a convincing rally. It could be a few more months before that happens. While we’re obviously happy about the October/November turnaround, in our view we will see continued volatility for a while longer. It is hard to have any conviction about the durability of this rally until we see a change in the trajectory of interest rates. Even then, the market will have to grapple with the new world of lower corporate earnings. How bad earnings disappoint will be determined by whether the Fed engineers a soft or hard landing.

There’s certainly a chance that this bear market rally stalls and the markets re-test their lows if the Fed ends up putting the economy into recession. However, at some point (possibly into mid 2023) the Fed will feel mostly satisfied with the lower inflation prints and will pivot to an accommodative policy approach.

If we can avoid a recession or experience only a mild one, this should keep the stock and bond markets from declining much from current levels. In addition, because stock and bond prices move in advance of economic developments, a soft economic landing is extremely important for a reliable, durable recovery in risk asset prices. Until then, patience is the key.


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