A Change in the Weather: Is the Summer Rally Over?

 After advancing four straight weeks taking the S&P 500 up 17% of its June low, socks retreated 1.3% in the past week. However, beneath the surface the damage was far greater with the leading edges of the bear market and the recent rally falling by a far greater amount. For example, Cathy Wood’s Ark Innovation ETF is now off 13.5% from its recent high and Bitcoin, the poster child of the bull and bear market, is down a similar 12.5%. As we noted previously crypto currency has been deeply embedded in both the bull and bear cycles. (See:  Shulmaven: The Crypto Crash and the Bear Market in Stocks)

 

When we wrote two months ago, we thought the bear market was entering its “anger phase.” (See: Shulmaven: The Bear Market Enters the Anger Phase ) It seems that lasted for only about a week as stocks embarked on the previously discussed 17% rally. For awhile it seemed that all anger had left the market as high valuation money losing companies led the charge and the “meme” stock mania returned in near full force.

 

Nevertheless, under the surface all is not well. The great bond rally that took 10-year yield down from 3.48% in June to 2.60% in early August has reversed with the yield closing at 2.99% on Friday. Further the market seems blind to the fact that inflation is not quiescent. As of July, the CPI is up 5.4% from the start of the year and by December, using some very modest assumptions, it will still be up 6.5% on a year-over-year basis. Similarly, with the core CPI is up 3.7% thus far this year, it more than likely than not, it will close out the up around 6.3%. 

Further you have to remember that if the CPI were calculated on the same basis as it was in the 1970’s, inflation would have peaked in the 12%-13% range, not the 9.1% reported. With data like this, the Fed will continue to tighten policy making it more likely than not, the terminal funds rate will exceed 4% and we have yet to see the full force of its quantitative tightening program which will start in a few weeks. That action will double its balance sheet shrinkage from $45 billion/month to $90 billion/month. We will learn much from the Fed this week when Chair Jay Powell delivers his remarks at the annual Jackson Hole Conference.

 

So just as summer turns to fall, the recent rally is likely over, and the anger phase of the bear market will resume. My guess is that we are heading for a retest of the June lows. Only then will we move to the final acceptance stage of the bear market.