Unstoppable Market Momentum: The Current State of Affairs

Market Resilience Amid Cooling Inflation and Retail Sales

With the recent slowdown in US inflation and retail sales, the possibility of the Federal Reserve cutting interest rates is back on the table. This, coupled with the lack of significant obstacles, could potentially propel stocks to new heights. Despite perceived delays in rate cuts, stubborn inflation, and signs of a slowing US job market, most equity markets have managed to recover their losses from April. This resilience indicates that the stock market is seemingly unstoppable for now. Factors such as loose financial conditions, a stable economy, a bullish technical picture, and a reassuring earnings season are contributing to this momentum.

Optimistic Market Sentiment and Bullish Momentum

According to Charles Hepworth, Investment Director at GAM Investments, market sentiment is on the rise as inflation hasn't spiked and retail sales appear to be slowing down. He suggests that the moderating landscape translates into lower volatility and easier predictions, which in turn could continue to drive the market upwards. The momentum is currently favoring the bulls with all major markets moving confidently into higher gear. There are only a few minor overbought warnings flashing so far, leaving room for stocks to rise further while limiting setbacks unless there is a significant shift in the fundamental perception of the environment.

Increasing Bullish Outlook on European Macro-Economic Growth

A recent survey by BofA of European fund managers reveals a growing optimism about the macro-economic outlook in Europe. A net 61% of respondents anticipate stronger European growth over the next year, a significant increase from 50% last month and the highest since July 2021. Meanwhile, only 22% of investors foresee growth slowing in the near term due to the delayed impact of monetary tightening, a decrease from 83% at the start of the year.

Potential Volatility and Real Rate Risks

Despite the current bullish momentum, the possibility of increased volatility during the summer months cannot be ruled out. Further rate-cut repricing might occur while inflation, despite slowing down, is still above the target. Natixis strategists Emilie Tetard and Florent Pochon warn that real rate risk is still a concern. They suggest that the situation observed in April, when rising real rates impacted risk assets, could potentially recur in the medium term due to persistent inflationary risk, uncertainties over the 'neutral' rate level, and increasing budget deficits. They recommend the dollar, defensive sectors, and low vol style as the best hedges against real rate shocks.

Equity Volatility Risk and Bullish Technical Picture

Equity volatility risk measures from VVIX to skew and tail risk pricing had increased ahead of CPI, albeit from a low level, but are already being compressed again after the inflation print. Option trading desks note that dealers are back into a long gamma environment. While this doesn't necessarily boost the upside, long gamma acts as a stabilizer in markets and a volatility dampener, both of which are beneficial in the current environment with plenty of upside catalysts. According to strategists at Tier 1 Alpha, the put/call skew remains low, and premiums only saw a modest increase, indicating that overall hedging demand remains subdued. This suggests that although there are signs of potential volatility, the market is not yet in a state of high anxiety.

Bank of America technical analyst Stephen Suttmeier maintains that the technical picture remains bullish. He points out that the advancers-decliners line of 73 country indexes continues to hit new all-time highs. Specifically referring to Europe, he states that the Euro Stoxx 50 remains in a bullish trend after a breakout from a cup and handle pattern, suggesting further upside towards 5230-5360 and the 5500s, as long as the 5000 support level holds. "Equity market strength is global and broad," he says. "We view this as bullish."

Closing Thoughts

It's fascinating to observe how the current market dynamics are unfolding. The resilience of the market amidst cooling inflation and retail sales, coupled with the bullish momentum and optimistic outlook on European growth, paints an interesting picture. However, potential volatility and real rate risks cannot be ignored. What are your thoughts on this? Do you think the market will continue to rise or are we due for a correction? Share this article with your friends and let's get the conversation started. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.