Whither the Rally?

What a week.  After beginning it with a -2.4% drop in the S&P 500 (SPX) on Monday, that index was up +3.8% for the week through yesterday.  That’s one heck of a reversal.  Since then, the most frequent question that I’ve been asked is “why the huge rally and how long might it last?”  There are several reasons, which we will attempt to elucidate below. 

There were several reasons why the rally was well deserved:

1. Market friendly messaging.  Investors finally got the sense that the President who viewed the market as a barometer of his job performance has returned.  Remember, the post-election rally was predicated upon:

1. A market friendly Administration
   1. Deregulation
   1. Tax cuts

Items (b) and (c) did not prove to be the immediate priorities of the administration, and the first major economic policy that was implemented – tariffs – was  not something that most investors neither wanted.  Then, to make matters worse, its rollout was not well handle.  Then, when President Trump initially dug in on tariffs rather than assuaging market concerns, it was very jarring for investors.  He has since amended his approach, and stocks appreciate it.

• More Bessent, less Lutnick and Navarro.  Yes, like Treasury Secretary Bessent, Commerce Secretary Lutnick is also a Wall Street guy, but his style of messaging and public embrace of the ill-fated “Liberation Day” announcement was not loved by investors.   Even though it was reported that Lutnick joined Bessent in appealing to the President to pause tariff implementation, it is clear that investors prefer the Treasury Secretary’s sober delivery than the Commerce Secretary’s histrionics.

• We were VERY oversold.  In circumstances like that, we can – and did — easily flip from one extreme to another

• Companies are getting a relative pass.  In recent quarters, failing to meet guidance almost certainly led to a nasty selloff.  But thanks to the tariff uncertainty,they have been able to waver on guidance as long as they don’t overtly cut it.  If there is a plausible to do so, managements are being allowed to push off negativity until next quarter.  That is allowing analysts to continue to price in double-digit earnings growth for the S&P 500, and if that is achievable – a big “IF” – then we’re not overpriced

Yet there are still valid reasons for caution.  Those include:

1. Bear market rallies are short, sharp and ferocious.  Keep in mind that some of the biggest rallies in history occurred during bear markets.  FOMO is always a powerful motivator, so once traders get the sense that they might miss a rally, they dive right in. (OK, the bear market in SPX lasted for maybe a few minutes, but it was substantial nonetheless.)

• The volatility of the recent move is not necessarily a sign of enthusiasm – it can also reflect uncertainty.  Just because this is “socially acceptable volatility,” it’s still volatility, nonetheless.  And volatility is the manifestation of uncertainty.  Remember how one of the features of the recent bull market was how rare it was to see outsized moves in either direction.  We literally went years without a 2% daily move.  Now they come almost daily.  The former reflected consensus, the latter ongoing uncertainty.

• The earnings forbearance can’t last.  Barring a major change in tariff policy or an incredibly rapid array of bilateral trade deals, companies will eventually see concrete effects of tariffs and will no longer be able to forestall changing guidance.  It would mean that the market’s expectations for 2025 earnings are far too high.  Bear in mind that when markets were plunging, it was too quick to know exactly whether it was multiple contraction shrinking the P/E ratio or earnings expectations implicitly contracting.  It was probably some of each.  But if earnings expectations are getting reduced, the major indices will suffer.

This morning’s activity is not giving us many clues about whether the rally is likely to continue or pause.  So far today, traders seem more interested in digesting a wild week rather than taking on new positions.  It’s hard to blame them.  I’ll be watching to see if the afternoon brings profit-taking, another attempt to goose the market higher, position squaring stasis, or some combination of some or all of them.  I suspect that position squaring will win out, especially because the President will be on a plane for Italy and unlikely to provide any market catalysts.

We got the latest UMich numbers as I was typing this.  The good news is that the sentiment (52.2 vs. the prior 50.8 and 50.5 consensus) and 1-year inflation expectations (6.5% vs. the prior 6.7% and 6.8% consensus) were better than feared, but the bad news — and reality — is that they still stink.  They’re a reminder that the economic backdrop remains highly uncertain, and thus so will the markets.  This leads me to think that selling rallies is the better path than chasing them.