Bulls at Risk of Falling Prey to Bear Market Rally, Charts Show

(Bloomberg) — The list of obstacles to the stock market rally gets longer by the day.

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Equities had a blast in July with those in Europe and the US rising the most since 2020, yet it’s a long way from a short-term bear market rally to a sustained move higher. And with Tuesday’s historic visit of US House Speaker Nancy Pelosi to Taiwan came another headline risk that could derail sentiment.

READ: Surging Stock Market Is Heading Into Riskiest Months of the Year

“The emerging Goldilocks narrative feels misplaced,” Barclays strategists led by Emmanuel Cau wrote in a note. Hurdles to an extended rally include ambiguous Federal Reserve communication, stagflation in Europe, an earnings season with mixed guidance and pressure on margins.

Here are five charts that indicate it may be a while before a floor is reached:

Short-Lived Rallies

Big bear market rallies are no guarantee of a bottom or a market turn. During the three years of the dot-com meltdown in the early 2000s, the Nasdaq 100 Index had nine monthly rallies of more than 10% before forming a base.

Spreads Cautious

Bond and equity markets have a vastly differing view of risk right now. The iTraxx Europe Main Index, which provides a measure of the risk premium investors are asking to hold corporate debt, is highly elevated, in stark contrast to stocks. Equity markets are showing “a little bit of complacency” and “not fully taking into account the risks,” Goldman Sachs strategist Sharon Bell said in a Bloomberg Television interview on Wednesday.

Earnings Cuts

An analysis of the past four recessions by Bank of America Corp. showed that the S&P 500 Index bottomed only after earnings per share forecasts had fallen either to or below the level they were at when the market last peaked. While profit projections have eased lately, they’re still about 6% higher than at the time of January’s record high.

READ: A Market Bottom May Need More Cuts to Estimates: Earnings Watch

The data also underscore a big divergence in how far estimates need to fall in order for stocks to find a bottom. In 2020, when the recession was the shortest on record, forecasts declined just 3% before a floor was reached. During the global financial crisis, the profit estimates sank 36%.

Seasonality

The S&P 500 just entered a period of the year when it has shown its worst historical returns. Together, August and September have averaged declines of 0.6% and 0.7%, respectively, over the past 25 years. Volatility usually rises during the summer and early fall months amid thin liquidity during the holiday season.

Not Cheap

Based on long-term price-to-earnings, or the cyclically adjusted price-to-earnings ratio (CAPE), global stocks remain expensive relative to history, even after a sharp fall in valuations since the start of the year.