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Is this stock market rally the beginning of a new bull market?

As we have always said, anything is possible with financial market prices, since they are ultimately driven by investors shifting between optimism and pessimism en masse due to herding behavior, which is an ancient survival mechanism for humans.

But at this point, the recent rise in stock prices appears to be another bear market rally until proven otherwise, since the weight of the evidence of our fundamental and technical indicators remains decidedly negative.

Short Covering Rally?

So far, stock market volume has been subdued, suggesting this rally is being driven more by “short covering” (short sellers “covering their shorts” by buying the stock back that they have borrowed and shorted) rather than real long-term buying. Also, the leadership in this rally has been the most beaten-down sectors and stocks, such as Tech and Consumer Discretionary stocks.

For example, Tesla (ticker: TSLA) had fallen 75% from its late 2021 high through early January. But in the past three weeks, it has rallied 50%. It is expensive at 45x forward EPS (Earnings Per Share) now, up from 30x three weeks ago, and the earnings outlook is not one that makes for a great stock. EPS is expected to decline 3.2% this year and 100% of EPS estimate revisions have been negative over the past three months. EPS estimates for 2023 have been cut by 32% since October. This is not the typical foundation to drive an expensive “growth stock” like TSLA to new highs.

The chart below of the NASDAQ 100 ETF (ticker: QQQ) shows this rally has now brought this tech-heavy index back to overbought levels, per the Stochastics and RSI. We placed red vertical lines on the three previous times the QQQ was overbought like this. All three times were followed by significant price declines. The same is true for the S&P 500 and most other major stock indexes.

QQQ

Financial Conditions Have Eased…

Related to the rally in stocks, financial conditions have eased significantly in the past three months, as shown in the chart below of the Chicago Fed National Financial Conditions Index (blue line) and the Wilshire 5000 stock index (red line). Typically, easing financial conditions (falling blue line) coincide with rising stock prices (rising red line), although that did not happen in the early 2000s stock bear market.

Financial Conditions

And Commodity Prices Have Risen…

One important aspect of easing financial conditions is that many commodity prices have been rising lately, which will add upward pressure on inflation going forward. That is the opposite of what the Fed has been trying to achieve with their tighter monetary policy.

Here are some key commodities that have increased by double-digit percentages from their lows of the past year:

Oil +14%
Gasoline +28%
Agriculture +11%
Lumber +37%
Copper +35%
Gold +19%
SIlver +34%
Bitcoin +48%

Which Forces The Fed To Keep Rates “Higher For Longer”

The next Fed decision and Fed Chair Jay Powell’s press conference is this Wednesday, February 1. The Fed is widely expected to raise the Federal Funds rate by 0.25%.

With the recent easing in financial conditions and rise in commodity prices, Powell will likely try to talk down financial market prices by emphasizing that they remain focused on lowering inflation toward their 2% goal and will keep monetary policy tight until that goal is achieved. With the unemployment rate at the lowest level since May 1969 at 3.5%, the Fed is solely focused on the inflation part of their “dual mandate” of maintaining stable prices and high employment.

Bill Dudley, who knows a thing or two about Fed policy since he is a former President of the New York Fed and Vice Chairman of the Fed’s Federal Open Market Committee, recently wrote that “for monetary policy to bite, financial conditions need to stay tight. If financial conditions ease, this just puts a greater burden on the Fed to keep rates higher for longer.”

This may be received negatively by investors, particularly with the market having rallied to overbought conditions, as has happened repeatedly when Powell has talked tough on inflation.

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