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Have Stocks Bottomed?

We asked three market strategists for their view on whether the worst is over.

There's one big question on the mind of stock investors these days: Are we out of the maw of the bear market?

We asked three strategists whether the stock market has seen its lows. Their answer: Yes. That’s not to say the worst is behind us from an economic standpoint.

And the market will likely stay volatile until it becomes more clearly established that inflation is abating, consumer sentiment is improving, and the economy is showing steady growth. But the worst is likely behind us in the equity markets.

The stock market has roared back to life since reaching a low this year on June 16. The Morningstar US Market Index has rebounded nearly 16% since mid-June and is now down 11.85% for the year. The Nasdaq Composite has risen 20% from its mid-June lows, which places it in a new bull market by one widely held definition. The tech-heavy index is now down 18.31% for the year.

Animal spirits are running high as the Federal Reserve Board's moves to tame inflation have gained traction. Companies delivered better-than-expected second-quarter results given the challenging environment. The Federal Reserve Bank of Atlanta's GDPNow economic growth tracker is forecasting 2.5% growth in the third quarter, after two straight quarters of economic contraction.

Back-to-back inflation reports on Wednesday and Thursday showed prices declining in July from June, unleashing a wave of euphoria among investors and driving benchmark indexes to their highest levels since spring.

“June probably does represent the low in the equity market,” says Jack Manley, global market strategist at J.P. Morgan Asset Management, with $2.5 trillion under management. “But it won’t be a straight ride back and we anticipate more volatility. Who would have ever thought a reading of 8.5% on CPI would be a celebrated metric?”

Manley says “we’re not out of the woods yet” and he’s watching some key data points that will support a steadier upward trajectory in the market. The top of his list includes:

  • Weekly jobless claims and job openings: Job openings plunged in June to their lowest levels since September 2021, signaling a slowdown in what's been an extremely tight labor market. Softness is welcomed because it will ease wage-growth pressures that are at multidecade highs. "We won't see anything positive anytime soon," says Manley. "If the numbers continue to deteriorate, the Fed would likely ease up on the pace of its interest-rate hikes and that would be a net positive for the markets."
  • Purchasing Managers' Index surveys: As forward-looking indicators, the PMI surveys for manufacturing and services provide early clues to the health of the economy. July's U.S. Manufacturing PMI reading of 52.2 while the weakest in two years, remained in growth territory and showed the smallest rise in the price of goods in a year and a half. The July U.S. Services PMI showed contracting growth at 47.3. "I'd like to see PMI at 50 or north of 50," says Manley, to be confident that business conditions would support stock market growth.
  • Consumer Sentiment: Current levels are abysmal and at the worst point in 50 years. "Retail therapy is a real thing in this country," says Manley. If consumers are hesitant to spend it will undermine the economy and the markets. "I'd like to see consumer confidence numbers move up."

There’s no question the markets bottomed in June, says Morningstar’s chief U.S. market strategist David Sekera, although he expects volatility to continue as investors keep having outsize reactions to data points. “The economy is on its way up and jobs are being filled at a healthy rate,” he says. “We were in rare territory in how undervalued markets had become.”

The four headwinds Sekera’s identified as having the most negative impact on the stock market have begun to dissipate. Those headwinds are now turning into tailwinds, he says, and include:

  • Economic growth: After two negative quarters of growth in gross domestic product, the economy is now forecast to grow at a rate of 2.5% in the third quarter. That meshes with Morningstar's forecast for average annual growth in GDP of 3% in the second half.
  • Fed tightening: With at least one and probably two interest-rate increases to come by the end of the year, that will likely mark the end to any new hikes, outside of the Fed's program to unwind its balance sheet, says Sekera.
  • Inflation: The June Consumer Price Index marked the high for the year, Sekera maintains.
  • Bond yields: The 10-year Treasury started the year at about 1.5% and is now at about 2.9%. While long-term yields could drift higher in the coming months as assets on the Fed's balance sheet run off, "the preponderance of rate increases is already behind us," says Sekera.

After buying trillions of securities to support the economy during the pandemic, the Fed is now in the process of reducing the amount of assets on its balance sheet, a process referred to as “quantitative tightening.”

Scott Clemons, chief investment strategist for Brown Brothers Harriman’s private banking division, with $60 billion under management, says he is “increasingly convinced we have seen the bottom.” What created a lot of downward pressure on the markets earlier in the year was anxiety-driven by whether the Fed was too late in combating inflation and, once the central bank began, was it too slow.

“It seems the fever surrounding the Fed moves has begun to break,” says Clemons.

Data he is watching closely for further confirmation that the upward turn in the stock market will last includes:

  • Inflation: The Consumer Price Index and Producer Price Index have both showed meaningful improvement recently, and he would expect further improvement as commodity prices, particularly gasoline, continue to ratchet down.
  • Fed tightening: The Fed is closer to the end of its tightening cycle, with the futures market anticipating rates at 3.00% to 3.25% by year-end. "That could be the much-needed relief" the market needs, Clemons says. He notes that there was a 120% rally in equities from March 2020 through January 2022 without any measurable pullback, making this year's 20% decline appear to be "the most normal thing that's happened in the past two years."
  • Consumer confidence: The current low levels, lower than what was recorded at the beginning of the pandemic, worry him, and sentiment will have to recover before we see lasting gains in the stock market.
  • Jobs: "It's hard to see a recession if we keep adding hundreds of thousands of jobs," says Clemons. The July jobs report, in which more than half a million jobs were added and which suggested the Fed would have to maintain an aggressive tightening stance, was likely an outlier. Adding 100,000 to 200,000 jobs would be manageable and healthy.

“If inflation ticks down and we get relief on consumer sentiment, that could spark a powerful rally,” says Clemons.

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