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Staying Power of the Rally Will Be Tested

Written by: Benjamin Bimson CIMA®, CMT® / CIO, Trek Financial

After a couple weeks of relief in the US stock market, the question about whether the worst is over or not, is a popular speculation. There are a few things that are encouraging, but it is too early to know whether this is a rally that will endure, or not. Inflation risk, along with hawkish central bank policy and geopolitical risks, makes this even more challenging.

After a difficult beginning of 2022, a rally in the stock markets are a welcome relief for those growing weary of negative stock market news. As market corrections mature, speculation about getting worse or better has become more common.

One concern that should not be ignored is the increased risk of recession. The quick rise of energy prices and the war in Ukraine have caused a shortage of supply that has led to an increase in prices. In most places, this is the highest it has ever been.1  This has led to an inventory pressure adding to the price pressures. Price spikes in energy have historically preceded most recessions (see chart below). However, it should be noted that not all price spikes have immediately preceded a recession, but coincidence is high.

Chart showing post-WWII price spikes and recessions. Chart Source: Ned Davis Research Group

Since energy is a basic input to nearly everything we buy and consume, there is rightly some concern about this in an already inflationary environment.

As parallels between the 1970s and 1980s cause people to cringe and worry, there is a little bit of comfort left that by the end of 2021 – food and energy still only accounted for about 10% of disposable personal income. That is roughly half of what they were in 1980. Of course, data lags and recent spikes from sanctions and the war in Ukraine are not yet present in the data. This is something that we will watch, but there does seem to be some room in average disposable income to absorb some price inflation. The longer it goes on and higher it goes, the more risk it will present.

Likely the staying power of the most recent stock market rally will be tested by ongoing developments on multiple fronts. Fed rate hikes, commodity prices, and geopolitical developments will likely dominate for the next few months at least. Remaining flexible is the key to not making big moves in these times. We believe that as things develop, clarity will also become increasingly evident for markets and opportunities.


Source

  1. CBSnews.com, March, 2022. cbsnews.com/news/gas-prices-record-high-oil/.

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