Stocks opened lower this morning, threatening to end the market’s three-day win streak before recovering through noon. Rising geopolitical tensions initially had investors feeling nervous with House Speaker Nancy Pelosi’s controversial Taiwan visit scheduled for tomorrow.
Pelosi’s set to touch down in Taiwan this Tuesday night, and China warned this morning that it would respond in some way if she made the trip. What that means, specifically, is unclear.
But it was enough to plunge stock futures lower immediately prior to the open. Chinese military drills commenced this morning, too, while the USS Ronald Reagan carrier strike group prepared to approach Taiwan. The strike group is already in the South China Sea but plans on moving closer to Taiwan during Pelosi’s visit.
The Chinese People’s Liberation Army (PLA) then released a propaganda video saying that it was “ready for war.”
This didn’t sit well with investors, but they were eventually able to shake off China’s posturing as stocks rallied intraday. The Dow, S&P, and Nasdaq Composite all gained slightly with tech leading the way.
Pushing higher from here without any sort of correction may be difficult, however, given how strong the recent bear market rally has been. In fact, July was the best month for the S&P since November 2020.
And that strength has led to an overbought market in the short-term, which Morgan Stanley chief equity strategist Michael Wilson believes could soon tilt bearish again.
“While the bond market is starting to assume they get inflation under control, it may come with a heavier cost than normal, potentially a recession while they are still tightening, which may leave a very small window for stocks to work before earnings surprise on the downside,” Wilson told clients in a note.
“We think that window is now but it can shut quickly. Risk reward is poor after the recent rally so trade accordingly as time may be running out.”
Wilson is perhaps Wall Street’s most powerful and well-known bear. Back when the pandemic began, he warned clients of an impending long-term bear market.
And he still thinks the indexes have far lower to go before a true recession bottom has been established.
Bank of America offered clients a similar take in a morning note.
“Summer is a great time to go camping, but we aren’t out of the woods yet,” wrote the bank’s analysts.
“Our bull market signposts also indicate it’s premature to call a bottom.”
B of A tracks a number of “bottom indicators” that have historically coincided with bear-market bottoms. The bank says that when 80% of these indicators are triggered, a selloff bottom is typically right around the corner.
Currently, only 30% of those indicators have been triggered, suggesting that there’s much more room for stocks to fall.
A simpler (and arguably better) indicator of a bottom, however, has to do with the Fed (like everything else in the market). Bear markets usually end whenever the Fed starts cutting rates.
And we’re not going to see that happen for at least another six months.
So, while the July rally was certainly exciting, it probably didn’t mark the beginning of the end of the bear market. That means investors need to be wary of bearish reversals this month as new data rolls in, potentially altering the market’s rate hike expectations for the Fed’s upcoming September meeting.