Why did the S&P 500 rally last month?

Wall Street has had a torrid year after slipping into a bear market in June. 

The S&P 500 in particular faced a difficult first half of the year in the face of soaring inflation and rising interest rates.

But last month the blue-chip index staged a comeback, rising 9.1 per cent in July. The Dow gained 6.7 per cent while the Nasdaq jumped 12.4 per cent. By comparison the FTSE 100 rose 3.5 per cent in the same period.

The S&P’s recovery came despite the announcement of a second successive quarter of economic contraction in the US economy. Does this indicate that the worst is over for US stocks this year or is it a false dawn?

What is driving the market?

The Federal Reserve made its fourth interest rate hike last week as it battles to rein in soaring prices. The central bank said it would raise rates by 0.75 percentage points to try to ease price inflation but fears of a recession are growing.

Federal Reserve chair Jerome Powell may not believe the US is in a recession but recent figures show the US economy has contracted for a second successive quarter.

It seems almost paradoxical that stocks could rise in this environment but Ben Yearsley, director at Shore Financial Planning, suggests there is some logic.

‘The rationale being that as economic growth weakens investors are betting that Central banks may be more reluctant to aggressively increase interest rates and slower economic activity will help dampen inflationary pressures.’

The Fed’s comments that it will ‘become appropriate to slow the pace of increases’ were particularly welcomed by bullish investors.

Jason Hollands, managing director of Bestinvest, adds that following the rate hike, ‘investors have factored in a peak as to where rates will end up.

‘In fact, market attention has moved on from inflation driving higher borrowing costs to factoring in a mild recession which is therefore likely to temper the pace of further rate hikes.’

Better-than-expected results

A strong earnings season has also helped to push US indices higher. Apple and Amazon both reported better-than-expected revenues last quarter with upbeat forecasts.

Apple said parts shortages are easing and demand for iPhones has continued while Amazon said it forecasts a jump in revenue next quarter off the back of bigger fees from its Prime subscriptions.

Hollands says: ‘While earnings growth is slowing across most regions, it is still positive. Almost half of companies have now reported.

‘Overall some 74 per cent of S&P 500 companies that have reported have beaten consensus earnings estimates. If we compare this to Europe and Japan, around 57 per cent and 58 per cent of companies respectively have beaten estimates.’

Strong performance by leading tech stocks have also helped struggling growth funds stage somewhat of a recovery. 

Scottish Mortgage has been somewhat of a bellwether for global growth stocks, given its investment in the likes of Amazon, Tesla, as well as privately-held startups.

The investment trust, which is down 34 per cent this year, has rallied 18 per cent since the start of July.

Other investors are more sceptical of the bounce and tech stocks more broadly. Blue Whale fund manager Stephen Yiu recently revealed he had ditched its holdings in US tech stocks because of concerns about the impact of inflation.

The fund, which was co-founded by Peter Hargreaves, sold its position in Alphabet last month, after divesting its Amazon and Meta holdings, according to the Financial Times.

It now no longer owns any of the Faang companies – Facebook, Amazon, Apple, Netflix and Google.

Is it a good time to invest in the US again?

Investors who have relied on the US stock market for returns over the past decade were given a wake up call in June when the S&P 500 slipped into a bear market.

It is the S&P’s twelfth bear market since 1950 and its second in two years, after the pandemic closed most of the economy. In five months the stock market had crashed 21 per cent.

So does the recent market bounce mark the end of this bear market? It is unlikely. The previous 11 bear markets typically lasted 390 days and resulted in an average decline of 34 per cent, according to AJ Bell analysis.

Investors should be aware of the so-called bear market rally, or bear trap. This is when stocks rise quickly, usually triggered by short sellers covering their bets and value investors looking to buy cheap shares.

However, these rallies tend to be short-lived and end as quickly as they started.

Investors will have more economic data and earnings to digest this week, particularly non-farm payrolls which will give more insight into the labour market.

For UK investors looking to buy US shares, Hollands warns that the current exchange rate makes it more of a risk.

‘The US dollar has strengthened by 10 per cent against sterling since the start of the year. 

‘If this trend reverses – as it seems to have in recent days – there is a risk that underlying stock price gains could be tempered by currency moves.’

Yearsley adds: ‘The performance over the last month shows the problem with trying to time markets. Who would have guessed the response to another 0.75 percentage point rate hike would be the best day since November 2020 for tech and Nasdaq?

‘At the same time, old economy stalwarts such as banking and oil were releasing good profit numbers and bonds made a recovery. With so much uncertainty, portfolio balance is crucial – don’t have all your eggs in one basket.’