Stocks are facing 3 barriers to entering a new bull market, Wells Fargo says
Reuters/herval
- Stocks have rallied in 2023, but it isn't a new bull market yet, Wells Fargo says.
- That's because the market faces three barriers to a sustainable rally.
- Stocks historically bottom after the economy enters a recession and the Fed begins to cut rates, the bank said.
Despite the strong performance of equities through the first half of this year, stocks aren't in a new bull market yet, Wells Fargo warned.
The bank's strategists pointed to the S&P 500's strong rebound since bottoming at 3,600 in October, with the benchmark index now 23% higher than its October low.
Those gains have caused the index to officially cross the threshold of a new bull market, some commentators say, who have made the case that stocks could even notch new highs in 2023 on the hype around artificial intelligence
"We are less optimistic," Wells Fargo warned in a note on Monday. "With stock valuations full, we believe prices are unlikely to sustain recent highs as the economy rolls over. In our view, equity markets should continue to reside within this wide trading range that has been in place since April 2022," strategists later added.
The bank pointed to three factors that are preventing stocks from entering a true bull market – and suggest that investors could be in for more downside in the months ahead.
1. The Fed hasn't cut interest rates yet
The Fed likely isn't done raising interest rates, and markets are still a long way from a rate cut that would boost equities.
Central bankers have raised interest rates aggressively over the past year to lower inflation, though high rates have weighed heavily on asset prices. Stocks fell 20% last year as financial conditions grew tighter – and Fed officials have warned monetary policy will continue to tighten as inflation pressures linger.
Investors are now pricing in a 92% chance the Fed will raise rates another 25 basis-points at their July policy meeting. That would lift the Fed funds rate target to 5.25%-5.5% – the highest rates will have been since 2007 – a move that will likely weigh on equity prices.
2. The US hasn't tipped into recession yet
High rates also threaten to push the economy into a downturn. And though a recession hasn't been officially declared yet, there are warning signs flashing in different areas of the economy, from falling RV sales to cardboard box demand, more Americans pulling back on spending.
That spells trouble for equities, as stocks historically have bottomed after the economy enters a recession and after the Fed begins to cut interest rates. Neither of those events have happened yet, strategists said, suggesting more downside was on the way for investors.
3. Only a narrow portion of the market has rallied meaningfully
Most of the S&P 500's gains have been driven by a small group of large-cap tech stocks, with the excitement for AI leading investors to plow their money into the tech sector. Other sectors, meanwhile, have lagged. Small-cap, mid-cap, and large-cap indexes that aren't tech-heavy, like the Dow, have posted just a 3-8% gain from the start of the year.
Those returns are meager compared to those of the "Magnificent 7" tech stocks, with Nvidia, the group's best-performing member, gaining 195% since the start of the year.
"The market cap weighted S&P 500 index has so far outperformed the smaller-cap indexes as well as the equal weighted S&P 500 Index because this rally has ben driven almost entirely by a small number of large companies. This has not been a characteristics of a durable bull market," strategists said.