The major averages bounced back strongly this week, posting first weekly gains since the start of June: The S&P 500 gained 5%, while the Nasdaq rose 6% and the Dow increased 4%. Under the hood this week, energy was the only sector to close out the week with a loss, while consumer discretionary led to the upside followed by the healthcare and real estate sectors. Meanwhile, the U.S. dollar index remains at around the 104 level. Gold continues to hover in the mid-$1,800s region. WTI crude prices pulled back to $107 per barrel. The yield on the 10-year Treasury pulled back to the 3.13% level.

The big question after this week is whether we’ve seen the bottom in stocks or whether this small bounce proves to be nothing more than a bear market rally. Make no mistake, after this week's seemingly strong rally, the S&P 500 is still down 5% for June, and we're still far away from the top of the previous rally ($4200 on the S&P 500). The market is still in a well-defined downtrend, making lower highs and lower lows.  

That said, the incredibly sharp and fast collapse in commodity prices does serve to support the view that we could see inflation cool in the second half of the year, helping the Federal Reserve achieves its goal of bringing down inflation, and potentially they may not go as aggressive on the monetary front. Ultimately, this will be the upside risk for stocks towards the latter half of 2022 and 2023, that inflation cools and economic growth continues. We will be writing a detailed analysis on this front, titled "Recent sharp declines in commodity prices are exactly what the Federal Reserve and the stock market want."

In contrast, there is also the view that even though valuations have come down significantly (from S&P 500's ~21x forward P/E ratio at the beginning of the year, to now ~15x forward P/E ratio), they may need to go even lower as earnings are expected to be revised down. Make no mistake, the pressure on the economy is real, both from inflation front and monetary front. In the past, we've heard from big retailers like Target and Walmart announcing shortfalls in profit margins due to high inflation. A software giant like Microsoft had to pre-announce a miss for the second quarter (to be reported in the next few weeks) albeit mainly attributable to foreign exchange rates. Our favorite car manufacturer Ford Motors faces the risk of making no profit on the Mustang Mach-E due to high material costs, and also higher rates for auto loans are dampening demands.  

This conundrum is why we advise clients to remain cautiously optimistic of the market. Discipline trumps FOMO or knee-jerk reactions on sharp down or up days. Focus on strong fundamentals of portfolio companies, be disciplined with cost basis, and be prudent to trim positions when necessary. For the next few weeks until second-quarter earnings kick off, the market is trading in a news-vacuum environment. There will be no dependable information for the market to really trade on (such as earnings, Fed policy or inflation data), to make a stance for either the first or the second scenario that we've laid out. We will have to wait until the earnings come out.