Stock Market Rally Intensifies Debate Over What Will Come Next

Stock markets are on a tear, and investors face a tricky question: Will this rally last?

The S&P 500 index is on track for its fifth consecutive week of gains, its longest winning streak since the fall of 2021.

It’s a remarkable run, following drastic actions taken by the Federal Reserve to contain historically high inflation. Many investors feared that the Fed’s series of interest rate increases would push the country into a more severe downturn. But the S&P 500 is roughly 17 percent higher than a year ago, almost 24 percent above its low in October, and just 8 percent away from a record.

Some investors have even labeled this run the start of a new bull market, a period of exuberance that by one definition is marked by a 20 percent rise from a recent low. Once stocks cross this threshold, the bulls say, they tend to keep climbing.

Others warn that the recent rise could be a bear market rally — a short-lived stretch of optimism within a longer-running trend downward.

The case for a bull market

The bulls base their argument on signs of a resilient economy, cooling inflation and an end to the Fed’s cycle of interest rate increases.

Unemployment is low and consumers are spending, which has helped make corporate profits more buoyant than expected. Inflation has moderated, and the Fed opted for the first time in more than a year to leave rates unchanged at its meeting this week.

Analysts at Bank of America recently declared “the bear market is officially over,” noting that, historically, after rising 20 percent from a low point, over the next 12 months the S&P 500 has continued to rise more often than not. On average, the index has gained another 19 percent over that period, according to data going back to the 1950s.

The fear of missing out on bumper profits as stocks continue to rise could attract investors on the sidelines back into the market, extending the rally, the Bank of America analysts said.

Analysts at Goldman Sachs last week raised their year-end forecast for the S&P 500, predicting that the index would rise another 5 percent from its level last Friday. The index had already gained 3 percent by the end of Thursday this week.

One common criticism of the rally in the S&P 500 this year is that it has been largely the result of a few big tech companies soaring higher, such as the 200 percent rise in the stock price of the chip maker Nvidia. The average stock in the S&P 500 has risen just 7 percent this year, about half as high as the index as a whole.

However, a broader rally is beginning to take hold. The Russell 2000 index, which tracks the performance of smaller companies more exposed to the ups and downs of the domestic economy, has jumped 8 percent in June alone.

Why the bears don’t see it that way

Bears are focused on the obstacles ahead: Inflation has come down but remains historically high, and cracks are appearing in some important parts of the market.

The downfall of three midsize banks in the spring has led other lenders to turn more cautious, restricting credit and crimping the availability of cash to companies and consumers.

When it comes to banks, “I think there are more weak links out there,” said Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research.

Corporate bankruptcies have risen, and some investors fear that this is just the start of deeper trouble, as debts with low interest rates come due and borrowers face much steeper costs to refinance. That is a particular worry for the commercial real estate market.

Consumers’ savings have also begun to run low and credit card balances have risen.

The bulls believe the Fed is close to ending its war on inflation, but the bears fear that the final battle has yet to begin. Inflation is still running at more than twice the Fed’s target rate of 2 percent and could remain stubbornly high. That may lead the Fed to push rates higher and, crucially, leave them high for longer, further squeezing the economy.

This week, the stock market flinched when Fed officials unexpectedly forecast two more quarter-point rate increases by the end of the year. But such forecasts have been wrong before; investors quickly shrugged them off and stocks resumed their rise.

George Goncalves, head of U.S. macro strategy at MUFG Securities, thinks that is a mistake.

“The signaling that the Fed is doing, and the fact that they are committed to a higher-rate regime, means it is hard to fathom that we won’t see other risks surfacing and breaking along the way,” he said.