Should you trust this recent market rally? Here’s how Wall Street is advising their clients

Published Thu, Oct 20 202212:05 AM EDT

The solid rally in the S & P 500 last week prompted some investors to ask whether stock markets have finally bottomed. Wall Street analysts, however, have cautioned that there might be more downside before a bull market begins. While the mega-cap U.S. index has already tanked by more than 22% this year, only two out of the 10 metrics that Bank of America tracks to signal a bull market have turned positive. That means there's likely to be more volatility before a sustained market rally. Swiss investment bank UBS also warned that the outlook for the S & P 500 had "deteriorated" in a note to its clients dated Oct. 19. "In fact, the risk-reward outlook for markets has become unfavorable in the near term, in our view, reflecting a combination of persistent inflation, rising rates, falling growth estimates, and heightened financial stress," said Mark Haefele, the global chief investment officer at UBS Wealth Management. Goldman Sachs has also suggested that the index could bottom at 3,150 points by the end of the year under a "hard landing" scenario — referring to a recession caused by the Federal Reserve tightening financial conditions severely. Hedge fund manager Dan Niles said the "bear market rally" in October will continue until Oct. 25, when mega-cap tech companies report third-quarter results. The Satori Fund portfolio manager reiterated his belief that the S & P 500 will bottom at 3,000 points . How to trust a market rally? Analysts at Bank of America said historically — noting the past seven recessions since 1974 — the stock market has only rallied 12 months after the Fed first cut interest rates. Markets currently only expect the first cut to interest rates in the second half of 2023. The BofA report also said despite the bear market, stocks still are not "cheap enough." Analysts at the bank said their "Rule of 20" metric, which has a "perfect track record" for predicting a bull market, is yet to start flashing. For the "Rule of 20" metric to turn positive, CPI inflation plus the trailing price-to-earnings ratio should add up to less than 20. According to the investment bank, with the latest U.S. CPI at 8.2% and P/E at 17.39, this metric will need to fall by 5 percentage points before a bull market begins. Although the bank urged investors not to time the market bottom, its equity and quant strategy team earlier this month said it was better to be late than early in a bear market. The analysts point to research that showed that investors that waited for eight out of 10 metrics to turn positive had a higher chance of larger returns the following year. What will outperform in a bear market? Consumer staples and health care are expected to outperform when the market in this environment, according to UBS. Unlike previous recessions, the Swiss bank also prefers the energy sector to rise as companies deliver on dividends and buybacks. "We continue to prefer value and quality income relative to growth sectors. We also advise investors to seek defensives in their portfolio to brace for more choppy markets ahead," the bank said in a note to its clients.