Santoli: Stocks are digesting last week's rally, as traders figure out what's next

Published Tue, May 31 20221:07 PM EDTUpdated Tue, May 31 20221:10 PM EDT

There's a quiet digestion of last week's rebound rally to finish out a whipsaw month, with debate crackling about how much credence to give the surge off the May 20 low. The S & P 500 entered the week riding a 9% ramp of the intraday low of 3,810, up more than 6% last week alone and boasting three consecutive days of sharply skewed upside volume. That usually speaks of buyers' urgency and tends to improve the risk/reward balance a bit. Specifically, more than 80% of New York Stock Exchange volume each day between Wednesday and Friday was in advancing stocks — something that has only happened ten times since 1980. Of those, two came before another major down leg into a bear-market low (late 1980 and January 2009), while the other eight were near the start of major, extended up moves. Good odds, but with scary exceptions. Similarly, there have been only 25 weeks since 1950 when the S & P 500 was up more than 6%. Before last week, another came in mid-March of this year. Of the ones before 2022, the market was up three, six and 12 months later 74%-83% of the time, with above-average median gains. However, the exceptions were within multiyear bear markets associated with economic recessions (1974, 2000-02, 2008-09), according to LPL Financial. In other words, how much weight one places on the strength of last week's run comes down to whether one believes this is a deep correction coinciding with policy normalization or a persistent bear phase that will beguile dip buyers on the way to much lower prices. For now, it seems that debate will be joined in earnest if and when the S & P 500 can advance by another 3-6% from here. That will take it up to and through its 50-day average and the 4,300 area that hasn't been overtaken for more than a moment in a month. Source: FactSet Still, the percentage of stocks pushing above their own 50-day average remains unimpressive/indecisive. When the market has been down year to date on Memorial Day by more than 5%, the rest of the year has tended not to be great, so there are plenty of conflicting messages from history. Still, there seems to be a consensus that what we saw last week was a bear-market rally. Morgan Stanley strategist Mike Wilson (early in his correct bearish call on the market) implicitly concedes this by saying this push higher could go another 5% before faltering. Energy has not wavered at all in its decisive leadership. It's stayed strong while humbled groups such as tech and consumer discretionary have had their springy bounces. Clearly crude oil ticking toward its March highs on the EU embargo headlines is supportive. Though strong uptrends do eventually tend to fail on good news — not bad — we're still waiting for energy stocks to lay a false step. Energy is also the piece of the macro puzzle that isn't yet cooperating with the "peak inflation" story. Yes, core inflation has cooled a bit and statistically goods pricing should soon be a drag on the price gauges. But, bottom line, we are in for multiple months of waiting for the Fed's needed "convincing evidence" of moderating inflation. Fair to say the market has made a temporary peace with the Fed on he outlook for the next couple of months, we'll see how far that get the markets. Today's Conference Board Consumer Confidence data contains some slippage in perceptions of job-market tightness, the difference between those saying jobs are plentiful and those seeing jobs as hard to get coming off the boil. It's still near highs, but this is heading the right way for the Fed, which wants wage growth to calm down. Source: Atlanta Federal Reserve , The Conference Board, SoFi At the recent market lows, the S & P 500 forward P/E got down toward 16-times — a neutral area. We started the year at 21.5x. Progress but not yet cheapness, if that's what's needed. But as noted here last week, this market has spent very little time under 16x forward earnings the last seven years or so. Fair to argue higher inflation and bond yields mean it belongs down there, but neutralizing for the still-rich mega-cap growth names the index is under 15.5x. Credit spreads were on the brink of sounding a more clear macro warning two weeks ago, but junk debt has rallied nicely and largely has closed that gap. High-yield performance likewise recovered quickly in March (seen here through HYG vs. the Treasury ETF IEI ), so this is more the removal of a potential negative than an immediate upside catalyst for stocks. Source: FactSet Market breadth is soft, though not particularly ugly given the upside thrust last week. NYSE is 65/35 down/up volume. Small-caps giving up a bit more, mega-cap growth holding a better tone so far. VIX flattish, still above 25, but mostly just reflecting recent actual jumpiness in stocks rather than some fresh bid for downside protection.