With the market's strong rally off the lows amid the bearish market environment in 2022, the natural question for investors is whether or not a new bull market has begun. If this is a bear market rally, then investors should lighten exposure, while traders should consider shorting. And if this is a new bull market, then investors should use dips to increase exposure.

Here are some additional factors to consider beyond inflation:

Growth Stocks

Growth stocks have been kind of a leading proxy for the market. Many of the frothiest, peaked in the spring of 2021, while others topped later in the year. This was well before the broader market which topped in January of this year.

Interestingly, the inverse took place recently as many growth stocks bottomed in mid-May and made a higher low in mid-June, even though the indices and most stocks made lower lows in June.

Currently, growth stocks have been the strongest performers during this rally. One reason is that moderating inflation is leading to lower rates which put a bid underneath growth stocks. The other is that these stocks were heavily shorted which means that shorts are being squeezed.

It's also worth noting that 'junk' growth stocks with no earnings and high valuations are leading the rally, while more higher-quality growth stocks are lagging. This could be interpreted as a lack of institutional participation in the rally.

Recession + the Fed

In May and June, the calculus seemed simple. The Federal Reserve's hawkishness and determination to crush inflation was going to result in a recession.

This scenario could still prove to be correct, but it's clear that the economy is much more resilient than expected. This is evident with the recent jobs report which showed the U.S. economy adding more than 500,000 jobs. Additionally, the services segment of the economy expanded in July contrary to expectations. Finally, the hospitality & leisure segment of the economy continues to boom as indicated by earnings and economic data.


Earnings are also inconsistent with an economy that is on the verge of a recession. Although, bears might counter by saying that Fed tightening is just beginning to impact the economy.

As Q2 earnings season nears an end, analysts are now expecting that S&P 500 (SPY  ) earnings will increase by 4.8%. This is better than the initial 4% estimate. It is true that the bulk of this earnings growth is coming from the energy sector as ex-energy earnings are set to decline by 1%.


It's clear that the rally is justified and well-deserved given that earnings and economic data have been much better than expected, while sentiment and positioning reached extremely bearish levels. And if this proves to be the nadir in terms of earnings, then it's very possible that this is the start of a new bull market. Another bullish force would be inflation falling which would lead to lower long and short-term rates.

However, just like the economy has proven to be more resilient than expected, something similar could happen with inflation. This would mean the Fed keeps hiking and economic growth would be choked off, leading to a more significant contraction in earnings. This combination of higher rates and lower earnings would recreate the same dynamic that led to plummeting prices in the first-half of the year.