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Why Rebounding Stocks May Not Be a Good Thing

by WOOWinvest
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Why Rebounding Stocks May Not Be a Good Thing

After falling for the first 5.5 months of the year, the S&P 500 has rebounded 8.5% since June 15 and 4.7% since July 26, the day before the Fed raised rates.

Investors turned enthusiastic about stocks, in part because Federal Reserve Chairman Jerome Powell said after the rate hike that the central bank would eventually slow the pace of rate hikes.

News on July 28 that GDP contracted at an annualized rate of 0.9% in the second quarter led investors to conclude that the Fed may soon turn to rate cuts.

Never mind that the Fed said in its statement announcing the rate hike that it “expects continued rate hikes within the target range” [for the federal funds rate] would be appropriate. ” Never mind Powell saying, “The labor market is very tight and inflation is too high.” “

Bullish nonetheless

Still, investors are clearly becoming more bullish.Another sentiment-boosting factor is Apple (AAPL) – Get Apple Inc. Report and Amazon (AMZN) – Get Amazon.com Inc. Report Reported stronger-than-expected second-quarter revenue.

But not everyone is convinced that the inventory recovery will continue. “This is a rally in a bear market, not the start of a new bull market,” David Donabedian, chief investment officer at CIBC Private Wealth US, told Bloomberg.

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“If we are at a market bottom, we would expect the P/E ratio to be lower. While the stock market has partially recovered, we expect it to retest the lows we saw in June.”

The S&P 500 is still down 14% so far this year. As of July 22, the index’s 12-month forward price-to-earnings ratio was 16.7, slightly below its 10-year average of 17.0. The past 10 years have been a period when the S&P 500 has surged at an annualized rate of 11.38%.

Is it good or bad?

You would think a stock rally is a good thing, even if it’s just a bear market rally. But some say that’s not the case. That’s because rising stocks mean easing in financial conditions. The Fed is looking to tighten financial conditions to slow inflation.

As recently as July 29, the government’s personal consumption expenditures price index, the Fed’s preferred measure of inflation, surged 6.8% in the 12 months through June, the biggest gain in 40 years.

Financial conditions include dollar levels, corporate bond spreads, stock market levels, and interest rate levels.

Bill Dudley, former president of the Federal Reserve Bank of New York, told Bloomberg that potential gains in the stock market are “very limited” and that the Fed needs to tighten financial conditions to dampen employment, thereby pushing inflation down.

Clearly, the Fed will not stop raising interest rates until price increases are contained. So paradoxically, many investors want interest rates to fall so that stock prices rise. But a drop in interest rates is unlikely until the stock market slides.

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