Why the Stock Market Rally Could Be the Real Thing

The chief U.S. strategist at Ned Davis Research says to keep an eye on the Fed.

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The stock market rally of the past few weeks just might be the real thing, according to the top strategist at Ned Davis Research, but one big question remains: Can the Federal Reserve stick the landing?

“The Fed’s track record of tightening cycles without causing a hard landing is quite poor, about 25% of the time they succeed,” said Ed Clissold, chief U.S. strategist at Ned Davis. “And this is a harder one than normal.” 

The Fed’s task of reining in the highest inflation rate in four decades, a result of the Covid-19 pandemic and government response to it, has been further complicated by Russia’s invasion of Ukraine, now approaching its sixth month. Though energy prices have been falling, that might not continue.

“A lot of fundamental commodity analysts still have concerns over the intermediate- and long-term supply of natural gas, of crude oil, and even of wheat,” Clissold said. “But the markets seem to have moved past it, which is typically what markets do, once emotions start to settle down somewhat.”

Helping settle those emotions is that the worst fears over Ukraine haven’t been realized, even as the conflict has turned into a deadly stalemate with no good end in sight.

“Sentiment is all relative,” Clissold said. “Once you get past initial sentiment shock, it depends on the economic fundamentals. And that’s what’s going to drive the market.”

Clissold said the “technical action of the last few weeks has been very positive, the kind of broad-market rally that tends to happen at the beginning of sustainable moves.” And, with plenty of bearish money still on the sidelines, “there’s a `pain trade’ higher, potentially, from here.”

Investor sentiment has also been buoyed as the fate of those companies that decided to leave Russia is already reflected in stock prices and earnings. Plus, the U.S. is a very domestically oriented economy.

“So what the Fed is going to do will have a bigger impact on corporate fundamentals than what’s going on in Europe,” he said.

“The technicals say the rally can continue for a little while longer, at least,” Clissold said. “If inflation pressures continue to dissipate, like the good news we got this week, then maybe the Fed can pivot. And the situation resolves itself bullishly.”

Clissold said his team has moved from somewhat negatively positioned to neutral, “just respecting that positive take.” But he also suggests investors don’t get too comfortable.

“Geopolitical risk did not disappear,” he said. “Because markets have moved on somewhat, there is a risk that another flare-up would have a negative impact.” 

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