Bull vs bear tug-of-war teases investors

While it looked and seemed like a bull market was on the horizon by traditional standards, Fidelity International has warned investors to remain cautious of the potential for a “wily” bear market’s “false dawn”.

Fidelity Investment Director, Tom Stevenson, said while the S&P 500 index closing above 4,292 points on 8 June marked another turning point towards the traditional definition of a bull market, there is always room to revert to its “previous downward path”.

“The measurement of bull markets is more art than science,” he said.

“The stock market bear is a wily beast and enjoys pulling wishful thinkers into its embrace with this kind of sucker’s rally. This time around there are more reasons than ever to question whether this is the start of a sustainable bull market or another false dawn.

“The most important of these is the lack of breadth in the last six months’ recovery. The S&P 500 may have risen by 13pc since the beginning of the year but almost all of that gain can be attributed to the performance of a handful of the index’s biggest companies, almost exclusively technology stocks which have soared on the back of investors’ new-found enthusiasm for all things artificial intelligence (AI).”

Stevenson also said the way investors look at the market can change the perception of whether it has reached the bull point, either weighted by market capitalisation or equally across the board.

“Look at the US market through this equal-weighted lens and the performance year to date is not 13pc but just 3pc. Since the low point on 12 October 2022, the equal-weighted index has risen not by 21pc but 14pc. Impressive, but still a way short of that traditional bull market definition,” he said.

“So, as the headline index, but not the wider market, moves into bull market territory, investors face two key questions. First, is the recovery since October the real McCoy or just another bear market rally? Second, if we are at the start of a sustainable bull market, what is the best way of playing it?

“To answer the first question, you will need to address three subsidiaries: what’s happening to corporate earnings; where next for interest rates; and is the rally broadening out from those AI-focused tech stocks?”

Stevenson highlighted that the earnings picture is becoming more positive as time passes, with the consensus projecting only a modest four-per-cent fall in profits this year before an earnings recovery of around 10 per cent. The improvement of US inflation allowed the US Federal Reserve to pause its monetary tightening cycle, with history showing central banks “tend to stop [hiking] when they have reach today’s level of positive real, inflation-adjusted interest rates.

“For the bull market to be really sustainable it will need to broaden out from the tech stock leadership that has been the defining characteristic of the past six months. And there are early signs that this is happening,” Stevenson said.

“One last hurdle remains. Typically, bear market rallies run out of steam at or below the point where they have retraced 50pc of their most recent fall. A rally that breaks through this barrier usually goes on to become a sustainable bull market. Here the evidence is mixed. The S&P 500 index has clawed back 63pc of what it lost in 2022. But the equal weighted index is only 39pc of the way there.

“That suggests one of two things. Either this is a bear market rally that has overstayed its welcome and the technology leaders might be hardest hit in the correction. Or the bull really does have legs, and the rest of the market has some catching up to do.”