Beware of a ‘bear trap’ pullback in stocks after summer’s big rally, strategists warn

It appears a “bear trap” may be lurking in this summer’s big rally for the stock market, which could lead to painful losses for investors, Glenmede strategists warned in a report Monday.

Investors already appear to be reconsidering some factors behind this summer’s strong recovery, including reexamining hopes that the Federal Reserve may not raise interest rates as aggressively as previously thought.

The S&P 500 SPX,
-2.10%
has hit resistance after gaining nearly 17% from its mid-June lows and has recently focused on whether recent gains for the stock could quickly be erased, confirming a bear market recovery.

This may sound like an outlier, but Glenmede’s investment strategy team found four instances of multiple market bounces (see chart) in US stocks over the past 50 years or so when they looked at periods after the S&P 500 initially fell by at least 20% from a previous peak.

Bouncing bears are not that rare

Glenmede Investment Strategy, FactSet

Of the last six bear markets, four produced a series of short-lived rallies that averaged 6.5 ups. The S&P 500 confirmed its move into a bear market on June 13.

“The 17% rally from the June 16 low appears to be in line with historical bear market rallies, averaging over 17.8% retracement before reversing course to new market lows,” the team wrote Glenmede, in a note to clients on Monday.

“While an economic recession is not yet confirmed, the path ahead will largely depend on the differential effects of inflation and interest rates.”

Stocks were lower to start the week, with the S&P 500 down about 1.7% at last check after closing Friday 15.3% below its 12-month closing low of 3,666.77 set on June 16. according to Dow Jones market data.

The Dow Jones Industrial Average DJIA,
-1.88%
was off 1.9% on Monday, down more than 600 points, while the 10-year bond yield TMUBMUSD10Y,
3.033%
it was again above 3%. Higher benchmark lending rates can slow economic growth by making it more expensive for US companies and individuals to borrow.

Economists expect Federal Reserve Chairman Jerome Powell to emphasize this week in his Jackson Hole speech that the 2 percent inflation target remains a key goal, even if trying to reach it means triggering a recession. The rate of inflation in the 12 months to July fell to 8.5% from a 41-year high of 9.1% in June.

But federal officials warned in July that the U.S. central bank could move to a “tightening” stance, enough to slow economic growth as it works to reduce inflation from its highest levels in decades.

Reading: Here are 5 reasons why the rally in stocks may be about to turn into a bear market again

On the upside, however, there was hope that consumer prices may have finally peaked this summer and corporate earnings and consumer spending remained fairly strong, the Glenmede team said.

Even so, “markets continue to price in a relatively rosy earnings outlook as earnings continue to rise for the next three years.”

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