Here are 5 reasons why a bull run in stocks could backfire in a bear market

Some market gurus are starting to worry that a summer rally on Wall Street could begin to fizzle out, as the stock quickly went from oversold to overbought.

Gene Goldman, chief investment officer at Setera Financial Group, explained that there is potential for a pullback in stocks, even though the economy is in a better position than many Americans.

“There has been great news, but the market needs a bit of a pause. We just went very, very fast,” Goldman said in a phone call with MarketWatch.

To support this view, he pointed to a few reasons why Friday’s decline in stocks could continue into the next week, and possibly longer — even if it remains bullish on stocks over the long term. .

defensive zone again

Cyclical sectors outperformed as stocks edged higher in July and early August. But that trend seems to be coming to an end this week, as the defensive sectors have taken the lead.

“One sign that investors are panicking is the cyclical underperforming in defensive sectors, and we’re starting to see that now,” Goldman said.

Over the past week, consumer staples stocks and utilities were two of the top performers among 11 sectors of the S&P 500. As a result, consumers opt for Staples Sector SPDR Fund XLP,
-0.32%,
An exchange-traded fund that tracks the sector rose 1.9%, while the Utilities Select Sector SPDR Fund XLU,
-0.05%
1.3% gain

On the other hand, the two worst-performing sectors were content and communication services, the two cyclical sectors. Material Selection Sector SPDR Fund XLB,
-1.84%
was down 2.4% for the week, while Communications Services Select Sector SPDR Fund XLC,
-1.62%
3.1% shed.

Bond yields rising

Goldman said the rise in bond yields is another sign that stocks are on the verge of an uptrend.

Higher Treasury yields can pose a problem for stocks because they make bonds a more attractive investment by comparison. Stocks and bonds often moved closer together at the start of the year, as tighter monetary policy expectations from the Federal Reserve eroded both assets.

But that momentum seems to have shifted in August. Treasury yields turned higher earlier this month and began to rise before the stock hit a rough patch later this week.

Yield on 10 Year Treasury Note TMUBMUSD10Y,
2.984%
There has been an increase of 35 basis points since August 1, and it has climbed 14 basis points since Monday to 2.897%.

Bond yields rise with falling prices, and Goldman and others on Wall Street are now waiting to see whether stocks will follow the decline in bond prices.

See: Fed’s Bullard says it is leaning toward supporting 0.75 percentage point growth in September

so is the dollar

Rising Treasury yields and softer inflation have helped propel the US dollar higher, creating another potential headwind for stocks. ICE US Dollar Index DXY,
+0.58%,
The dollar, a measure of the strength of the dollar against a basket of rivals, topped 108 on Friday, hitting its strongest level in a month.

See: US dollar is on fire and slicing ‘like a hot knife in butter’ through key technical levels

A stronger dollar is generally associated with weaker stocks, as it reduces the foreign earnings of US multinationals in US dollar terms.

cryptocurrency is falling

cryptocurrencies like bitcoin BTCUSD,
-0.16%
and Ethereum ETHUSD,
-4.64%
Recently with stocks trading almost in lockstep, most notably Meta Platforms Inc. megacap technology stocks like meta,
-3.84%
and Netflix Inc. nflx,
-1.64%,
But the crypto sold out sharply on Friday, leaving some to wonder if the stock could be next.

“Another sign of market stagnation is weakness in crypto. This is a clear indication of risk appetite in the market,” Goldman said.

According to CoinDesk, bitcoin is down about 9.5% on Friday, while the second most popular cryptocurrency, Ethereum, is down about 10%.

Equity valuations not syncing with corporate earnings

Another reason to question the rally in stocks is that there appears to be a disconnect between equity valuations and corporate earnings expectations.

As Goldman reported, the S&P 500’s price-to-earnings ratio has rebounded from a low of 15.5 in mid-June to 18.6 times forward earnings. At the same time, corporate earnings expectations from these same companies have dropped from $238 to $230 over the next 12 months.

Goldman said, “The fall in earnings estimates is giving rise to stocks.

Goldman is hardly the only one troubled by rising equity valuations. In a recent note to the bank’s clients, Citigroup US equity strategist Scott Cronert said the risk of declining corporate earnings in 2023 could create a “valuation headwind” for the shares.

“We would say that it is appropriate to sell in a strategically forward strength,” he said.

US stocks were down on Friday with the S&P 500 SPX.
-1.29%
fell 55.26 points, or 1.3%, to 4,228.48, while the Nasdaq Composite comp,
-2.01%
It closed 260.13 points or 2% lower at 12,705.22. Dow Jones Industrial Average DJIA,
-0.86%
It fell 292.30 points, or 0.9%, to 33,706.74.

Friday’s losses for stocks pushed all three main benchmarks into the red for the week, marking the first weekly decline for the S&P 500 and Nasdaq in over a month.

Highlights of next week’s economic data calendar are expected on Friday, when Federal Reserve Chairman Jerome Powell prepares to deliver his annual speech from the central bank’s economic symposium in Jackson Hole, Wyo. Economists hope to use this opportunity to emphasize this point. The Fed’s commitment to combating inflation.

See: Powell will tell Jackson Hole that recession won’t stop the Fed’s fight against high inflation

In addition to hearing from Powell, investors will receive an update on the pace of inflation through the personal-consumption spending index, the Fed’s preferred gauge of price pressure. The University of Michigan’s closely watched sentiment survey, which includes readings on consumers’ inflation expectations, is also on Friday’s calendar.

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