How far up can the markets rally?

A simple answer is prices can rally to a new high. However, markets are usually not so simple, neither is a path to a new high. While this rally is likely to extend into the month of June, to avoid a new low for the year - markets have fundamental and technical hurdles to overcome and this is going to bring with it some volatility.

1.US Interest Rates: base case is another 100 bps hike in interest rates over the next two meetings and a likely pause for the rest of the year as macro economic data is analyzed. According to recent data from Refinitive, so far during Q2 2022, Lipper Short U.S. Treasury Funds (+$15.5 billion) and Lipper General U.S. Treasury Funds (+$13.9 billion) have pulled in the largest and second-largest inflows. Year to date the only fixed income Lipper classification that has topped these two is Lipper International Income Funds (+$34.4 billion). This data indicates that the US yields have likely seen a near term top. This is bullish for the equity markets as well, since the base case scenario is likely priced in. The risk: if inflation persists at the current levels and leads to further hikes this year, this is likely to be bearish for both equity and bond markets.

2.US Recession: From the recent economic data releases (manufacturing PMI, Services PMI and New home Sales), there are signs of a slowing down. However, jobs data reflect a strong labor market and retail sales continue to show growth over the previous year (Jan to Apr 2022; data as per the United States Census Bureau) both of which indicate that the US may avoid a recession. It is likely that the recent sell off in the equity markets were pricing in a recession (probably the reason for inflows into bonds as well) and if the US avoids a recession, equities will remain bullish and trend higher from these levels. The risk: The US economy does not avoid a recession and in such a scenario, likely to be bullish for bond markets since a recession will negate the risk of interest rate hikes and funds are likely to move into Govt bonds which are considered to carry lower risk than equities. A recession will be bearish for the equity markets in general especially due to lower capex and spending.

SP500 Weekly Chart

3.Technicals: The S&P500 is likely to face selling pressure and see pull backs as it navigates through 4100 - 4250. If equities trend higher from 4250, there is likely to be stronger selling pressure in the area between 4400 - 4550, particularly from the large fund inflows in Feb & Mar this year, post which the markets have seen a sharp decline of nearly -15%.