The 11% surge in U.S. stocks in the past two weeks has the hallmarks of a bear-market rally that might give way to deeper losses.
That's the conclusion of analysts at Bank of America, who say warning signs are flashing for a market that has climbed "despite clearly weaker fundamentals," including a Federal Reserve bent on raising rates sharply this year to battle persistent inflation.
The strategists caution that the selloff that took the S&P 500 12% from its January record is not over and sharp rallies are typical of volatility in bear markets, with some of the biggest on record occurring in the throes of the dot-com meltdown and the global financial crisis.
A closely watched Treasury market metric flashed a recession warning Tuesday, adding to worries a restrictive Fed will damage the economy.
"The worsening macro backdrop and market-unfriendly Fed make sustained U.S. equity gains unlikely," strategists including Gonzalo Asis and Riddhi Prasad wrote. The Fed isn't likely to come to the market's rescue at any point and, in fact, the central bank is welcoming of tighter financial conditions to aid its battle against inflation. "In practice, this means lower risk assets."
For now, investors aren't heeding any warnings. The S&P 500 jumped 1.2% Tuesday for its ninth gain in 11 sessions, even as the yield on two-year Treasuries popped above the 10-year rate for the first time since 2019.
But 10-day stretches of big gains have been common in bear markets. There were four that exceeded the 10-day rally of 10% through Monday in 11 bear markets since 1927, the BofA strategists wrote.
It's not hard to find reasons for caution. The war in Ukraine still has commodity markets in turmoil, with fertilizer the latest product to skyrocket in price. Oil prices are still elevated, adding to inflationary pressures the Fed has promised to tamp down, even if it damages demand.
The strategists recommend investors sell out-of-the-money calls to hedge against both downturns as well as any potential short-term run-ups, which they say will be "limited."
