US stocks rally: Not a new bull market but a ‘late cycle melt-up’, says market-research firm

The improvement in forward-earning estimates fuels the idea that “companies have successfully weathered the rate hikes", according to the analysts.

The current rally in the US stocks is late cycle melt-up and is not the beginning of a new protracted bull market, according to The Spread Site, a market research firm.

According to analysts, the sharp rally in 2023—S&P 500 has shot up to around 4,567—has many reasons and the crucial one being the Goldilocks effect.

Also read: The bear market has nearly been erased, fewer than 20 months after it began

They wrote, “Fundamentally, why do markets rally when policy is becoming tight and (in hindsight) a recession is getting closer? In our view, it is because the path from overheating to recession usually has to go through ‘goldilocks’ first. In other words, there is typically a period when rate hikes are nearly or completely done while jobs haven’t started rolling over that the market (prematurely) celebrates the Fed accomplishing the impossible, as we are witnessing today.”

This would be a misreading of the situation because unemployment lags hiking cycle by “a long period of time”. “Even in the high-inflation cycles of the 70s/80s when the Fed hiked right into recession, unemployment did not begin rising until late in the hiking cycle. In more recent episodes, unemployment did not begin rising until well after the hiking cycle was done, which drove sizable ‘goldilocks’ rallies,” they wrote.

Besides the belief that inflation has been tamed without a rise in unemployment, and therefore the hiking cycle maybe coming to a close, there are others that is driving the optimism about this rally such as the bottoming out of forward earnings estimates; the banking stress which may have slowed down the Fed’s rate-hiking cycle; and the overly bearish sentiment that was present in the beginning of the year.

The improvement in forward-earning estimates fuels the idea that “companies have successfully weathered the rate hikes".

Advice to investors

The analysts wrote that they haven’t told their investors to “pile into outright shorts”.

“Most of our recommendations have been relative value trades with a defensive bias, or expressing shorts through put spreads, that if wrong, allow you to fight another day,” they wrote.

“We continue to have this mentality – focusing more on the end game, then trying to precisely time the turn, recognizing that the latter is in part a guess, and that there is no telling how extreme valuations can get in the short-term,” they added.

Also read: US stocks end higher as markets await Fed rate decision

They added that they could “certainly” be wrong and that rising asset valuations drive renewed animal spirits and thus lead to a temporary re-acceleration in growth. “Even if that is the case, we think it does not change the end game, but just delays it, ultimately forcing an even more aggressive Fed,” they added.