Is it a bull market or a bear market bounce may not be the question

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The S&P 500 is more than 17% off its June 16 low and internal market data looks very strong. Over the weekend, Jurrien Timmer of Fidelity Investments noted that 88% of S&P 500 stocks are above their 50-day moving average. Perhaps more importantly, the S&P retraced 50% of its losses from the January 3 high to the June 16 low.

Based on this retracement, Timmer concludes: “If this rally continues much further than it has so far, on a historical basis, it will be difficult to conclude that this is not a of a new bull market.”

Sam Stovall of CFRA Research agrees. “History reminds us that the S&P 500 never set a low in any bear market after World War II after recovering 50% of that decline from peak to trough…history says that the lowest is already here.”

But even if it is a bull market, it is still expensive. The S&P 500 is already trading at more than 18 times forward earnings, up from around 16 a few months ago, which is expensive by historical standards. The S&P rose solely on the basis of an expanded P/E multiple: Earnings for 2022 and 2023 are both slightly lower than at the start of the third quarter.

When you approach a multiple of 20, you would traditionally make some kind of argument about an improving economy and potentially higher earnings, which is hard to do in this very choppy environment.

But bulls argue that the spike in inflation and the Fed’s pivot mean there is less risk to earnings, which should allow for a higher valuation.

If you think stocks are expensive, they could get even more expensive. We could get the opposite of what everyone thought was going to happen in August and September. We could have a merger.

How? Remember that many traders pulled out in May and June and were on the sidelines. With the market rallying, “the whole street is taken offside,” one trader told me. Some of the most shorted stocks, including stocks from memes like Gamestop, have rallied more than the market, which is a harbinger of a meltdown. As we go higher, this will force more investors who are now on the sidelines into the market, which can easily push stocks into overbought territory.

Which comes down to the basics: even bulls get nervous as the market moves higher.

“If the rally continues, I would have to respect the technical history of bear market rallies not exceeding a 50% retracement, and conclude that a new cyclical bull market is underway,” said Timmer, director of macro. Fidelity World. “But given the backdrop of earnings and valuations, even if the bottom is reached, it’s not easy (for me) to draw a compelling bullish narrative here. It seems the best hope for stocks is that earnings continue to grow in the mid-single digits, while valuations remain at current levels.”

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