The stock market is experiencing a bear market rally. And of course you know it well enough to stay away from it.
As of this writing, the S&P/TSX Composite Index is up more than 7 percent from its recent low, a huge rise in just a few weeks.
The S&P 500 index has gained more than 12 percent over this period. And the tech-heavy Nasdaq Composite Index is up about 16 percent.
All bear markets have their bear market rallies when investors buy stocks they think are undervalued.
The current rally is one of the strongest on record.
However, it’s less impressive when you consider what’s causing it.
Among them is FOMO, investors’ fear of missing the opportunity to buy at the bottom of the market.
Another reason is the belief that central bankers will ease their rate hike cycle.
That’s hard to imagine, given the steadfast determination of the Bank of Canada and the US Federal Reserve Board to keep inflation under 2 percent.
If that determination plunges the North American economy into recession, then eradicating inflation is in the bigger picture.
Or didn’t investors hear Fed Chair Jerome Powell when he said last week, “We think it’s necessary to have a slowdown in growth”?
In part because expectations of future corporate earnings are too high, Lisa Shalett, chief investment officer for wealth management at Morgan Stanley, the New York securities firm, warns that “there’s another 5 to 10 percent downside in stocks.
“Is this really the ‘buyable bottom’ in the 2022 bear market?” Shalett issued a note to clients in mid-July asking for more gains in the current bear market rally.
“And could the Fed start scaling back monetary tightening? We don’t think so.”
With few exceptions, bear market rallies are value traps.
Investors get stuck with stocks that either give up their recent gains or stop making more and remain dormant for a long time after their brief bang.
Stock purchases are based on future earnings growth and a higher stock valuation reflecting this.
This scenario is unlikely here.
Economic slowdowns tend to reduce corporate profits and stock prices.
And the US is now in a technical recession after last week reporting a second straight quarter of negative GDP growth.
Canada’s GDP growth was virtually zero in May and June.
Share prices have of course fallen sharply this year. The so-called “tech wreck” humiliation of former tech darlings began last year.
Even with this amazing wealth wipe-out, the S&P 500’s biggest first-half decline in decades, the market is still weaker than it looks.
Second quarter earnings reports now coming in suggest corporate earnings are healthy enough for the S&P 500.
However, this picture is distorted by several factors.
Part of that is that the second quarter tends to be strong. And booming earnings for energy companies, particularly oil and gas, are bolstering an otherwise slumping market.
So is the return to profitability of companies in the sectors hardest hit by the pandemic recession.
In the broader economy, the trifecta of inflation, rising interest rates and falling property values have dampened both consumer and business sentiment.
Canada’s economic leaders recently reported weak second-quarter growth. And they also expect persistent storms in the second half of the year.
These leading companies include Loblaw Cos. Ltd., Canadian Pacific Railway Ltd. and Shopify Inc.
In the US, similar warnings have been issued by Walmart Inc., Amazon.com Inc., Procter & Gamble Co., Google’s parent company Alphabet Inc., General Motors Co. and Microsoft Inc.
Ford Motor Co. is laying off workers and Stellantis NV, parent company of Chrysler and Fiat, is cutting jobs at its Windsor and Brampton plants.
Certainly the prospects for an eventual recovery from the Trifecta are encouraging.
TD Economics, for one, forecasts average annual inflation of just 3.5 percent next year, compared to the 8.1 percent reported for June. And it sees Canada topping its G7 peers for GDP growth in 2023 at 1.7 percent.
But right now, the stock market is vulnerable to nastier surprises.
These include dismal corporate earnings reports later in the year, inflation that lasts longer than forecast, larger-than-expected rate hikes and ongoing supply chain disruptions.
Hershey Co. warned investors last week that supply chain problems would mean the company would be unable to meet usual demand for Halloween and holiday candy this year.
When a company with 125 years’ experience sourcing supplies can’t keep up with demand during the peak selling season, you know the economy is still too shaky to bet your retirement savings on.
It might be best to keep even your play money cool until the market is a happy hunting ground for real bargains again.