These are the signs that the rally in stocks won’t last long, according to Citigroup

U.S. stocks have clawed back much of their losses since the first half of the year, but the three major stock indexes fell this week amid resurgent fears of interest rate hikes by the U.S. Federal Reserve, and there are signs that the biggest part of The bear-market rally is already behind us, Citigroup analysts said.

According to strategists at Citi Research, the current bear-market rally is roughly in line with the duration of an average bear-market rally, and sentiment has already improved as it usually does during regular bear market rallies, which would indicate a possible end of the rally relatively soon.

“Bear market rallies are often driven by sentiment as the market simply becomes too bearish,” Citi Research strategists led by Dirk Willer, managing director and head of emerging markets strategy, wrote in a note on Thursday. “More fundamentally, many bear market rallies are driven by hopes that the Fed will come to the rescue. The current one is no different, as the Fed pivot narrative has been a major catalyst.”

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In particular, the chart below shows that the AAII bull-bear index, one of the surveys of investor sentiment, is almost back to the levels where bear market rallies peak, with expectations that stock prices will rise over the next six months rising up 1.2 percentage points to 33.3% in the week of August 15, while bearish sentiment rose 0.5 of a percentage point to 37.2%.

SOURCE: CITI RESEARCH, BLOOMBERG

Meanwhile, the SKEW index for the S&P 500, which measures the difference between the cost of derivatives that protect against market declines and the right to profit from a rally, normalized to about as much as the bear-market rally median (see . chart below), Citi Research said. The index can be an indicator of investment sentiment and volatility.

SOURCE: CITI RESEARCH, BLOOMBERG

Federal Reserve officials in July agreed that it was necessary to move their key interest rate high enough to slow the economy to combat high inflation, while expressing concern that they may end up tightening monetary policy more than necessary, according to with the minutes of the Federal Reserve Bank. The July 26-27 meeting of the Open Market Committee was released on Wednesday.

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Following the publication of the minutes of the meeting, the President of the Fed of St. Louis Governor James Bullard said he was leaning toward another big rate hike of 75 basis points at the central bank’s meeting in September. Meanwhile, Richmond Fed President Tom Barkin said the Fed “will do whatever it takes” to drive inflation back to its 2 percent target, according to a Bloomberg report, while Reuters cited Barkin as saying the results of the Fed’s efforts need not be “devastating.”

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According to Citi research, a bear market rally refers to a bounce of 10% or more that occurs between a peak and trough. “If a new low is made after a 10% rally, the next rally above 10% is a separate bear market rally (or a bullish rally if no new lows are made afterwards),” the strategists wrote.

The S&P 500 SPX,
-1.29%
rose 15.4% from a 52-week low of 3,666.77 on June 16, while the Dow Jones Industrial Average DJIA,
-0.86%
the Nasdaq Composite COMP also rallied 12.9%,
-2.01%
jumped 19.4% from its mid-June low, according to Dow Jones market data. In total, Citigroup noted that three indices rose 17% in the 42 trading days since June 16.

US stocks ended the week sharply lower. The Dow Jones Industrial Average DJIA,
-0.86%
fell 292.30 points or 0.9% to end at 33,706.74. . The S&P 500 SPX,
-1.29%
fell 55.26 points, or 1.3%, to end at 4,228.48. The Nasdaq Composite COMP,
-2.01%
down 260.13 points, or 2.0%, to 12,705.22.

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