The Major Role Played By Short Covering Raises Questions
The Ongoing Debate Between Bull Market And Bear Market Rally
The current rally by U.S. stocks since mid-June is gaining a growing number of adherents each day to the notion that we are witnessing the birth of a new bull market rather than a rally in an existing bear market.
The strength of the rally since June certainly paints a bullish picture that can console that optimistic investor that has endured significant losses in 2022. As much as we would like to see a new bull market, our optimistic desires are tempered by the burden of our experience as a money manager, which compels us to cast a skeptical eye.
The accompanying chart belowprovides one reason why we are inclined to view current market action as a bear market rally rather than a bull market. The covering of short sales has played a role in the market’s recent rise, with issues that were associated with the largest short positions appreciating at a much faster rate than the S&P 500 index. New bull markets are typically led by the leaders of that bull market, not heavily shorted stocks of dubious value.
Other factors cause us to remain cautious, such as the Fed likely to continue with its policy of aggressive interest rate increases. We believe rates will continue to be increased until evidence of a sharp recession is evident, which will hurt corporate earnings. Weak earnings are not the fuel of bull markets, especially since markets are already richly priced.
The absence of evidence of a change in Fed policy, and a surprising (at least to us) amount of residual investor apathy cause us to view the current market environment with caution. Each month in the Global Investment Letter I update my investing activities, as well as comment on major global equity, fixed income, currency, and commodity markets.
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