Since January 24, the stock market has put together a decent rally out of oversold conditions. The natural question is whether this was simply another dip in an ongoing bull market or more of an oversold bounce or even a bear market rally?
The implications are quite significant. If this remains a bull market, then it's likely that we have bottomed and any dips are buying opportunities. Further, the lows are unlikely to be retested. On the other hand, if this is a correction then it's likely that the lows will be retested or undercut, while if it's a bear market, then this bounce could prove to be the last selling opportunity for quite some time.
Of course, what will happen rarely fits neatly into these parameters and is only obvious in hindsight. However, it does provide a framework to evaluate new data as it comes in and also gives some realistic understanding of risk and reward.
The bear market outcome is simply that growth is decelerating while the Federal Reserve is tightening. In a sense, this is an inverse of what happened during the initial months of the rally when growth was picking up, while the Fed remained very dovish. I believe this outcome is what is worrying the markets rather than other possibilities like the Ukraine-Russia conflict or even inflation.
And, there are some good reasons to believe that growth could slow in Q1 especially with the stimulus and child tax credit expiring in addition to inflationary pressures which show no sign of abating.
The next possibility is that this is a garden-variety, market correction that tends to have a big drop, weeks or months of choppy trading, and then finally a secondary low that leads to more favorable market conditions and better opportunities for traders and investors. This tends to happen when a bull market hits a significant road bump but underlying conditions remain supportive. In essence, the economy's growth and positive momentum are strong enough to overcome the headwinds from inflation and a tighter Fed. One piece of evidence supporting this is that Q4 earnings seasons have been stronger than expected with earnings growth now at 29% vs 21% a month ago.
The final possibility is that this is a market dip with an almost V-shaped, type rebound. This possibility seems increasingly less likely especially as we saw significant selling and deterioration at the end of last week. However, since March 2020, every correction has been of this variety.