From mid-June to early August, the stock market went on a huge tear, gaining nearly 20%. The major catalysts for this rally were improvements on the inflation front, better than expected economic data, and an oversold market with extreme levels of bearish sentiment and underinvested fund managers.
There were some who believed that the rally was actually the start of a new bull market as the combination of a resilient economy and falling inflation indicated that a 'soft landing' was more likely. Others saw the market's rebound as a 'bear market rally' which would inevitably lead to lower lows.
The jury's still out on which side will be ultimately proven correct. However, recent price action is consistent with a 'bear market rally' idea as the market has given up about 50% of its gains from the June lows. The market climbed from 3,600 to 4,300 and is currently trading between 3,900 and 4,000.
Yet, the door simply can't be shut on the bull case especially as long as we are trading above the previous lows. In fact, it could be argued that the fundamental situation is much better than it was at the mid-June lows from nearly every perspective.
The economy has continued to be proven resilient even after absorbing 3 more months of higher rates as evidenced by the latest jobs report. Inflation has meaningfully turned lower with consecutive prints of lower numbers, a flattening in the monthly figures, and leading indicators turning lower.
Some of the extremes caused by the pandemic have also normalized including freight prices, used car prices, and the housing market which should continue to feed into lower numbers. Additionally, oil prices are also much lower and are now decisively below when the Russia-Ukraine war started.
But, while fundamentals are much better than a couple of months ago, sentiment measures are back at extreme bearish levels even with the S&P 500 (NYSE: SPY) nearly 10% higher. This is evident by measures showing ETF inflows, institutional hedging, and sentiment surveys.
Given this divergence between fundamentals and the market, traders should consider getting long with a stop at the June lows.