After S&P 500's best month since 2020, analysts look for bear market's end

Battered by the worst first half of the year in over five decades, the S&P 500 recovered strongly in July with its best monthly performance in almost two years, marking a potential turning point in the U.S. stock market.

With the most aggressive Federal Reserve rate hikes arguably now in the rearview mirror and the possibility that inflation has hit its peak, many analysts believe that the July rally could be the start of a new run for U.S. equities.

"Traders may look back at this as the month the bear market of 2022 ended," said Matt Weller, global head of research with FOREX.com and City Index.

In July, the S&P 500 climbed 9.11% after falling 8.39% in June. It was the S&P 500's best performance since November 2020, when it climbed 10.75% that month. The large-cap index remains down 13.34% through the first seven months of 2022.

Although inflation has yet to turn and U.S. GDP has shrank for two consecutive quarters — the technical definition of a recession — traders are betting on easier financial conditions as the Fed prepares to "pause" the rate hike cycle later this year and possibly start to cut rates again at some point in 2023.

"We've seen higher-growth, economically-sensitive sectors like technology and consumer discretionary lead to the recovery rally as traders bet on easier financial conditions sooner than previously anticipated," Weller said.

Consumer discretionary stocks, which have been hammered all year by expectations that soaring inflation would eat into consumer demand, jumped 18.9% in July, making them the best performing of the S&P 500's sectors.

"Big tech got hit the hardest and now the heavily weighted mega-cap tech stocks are looking attractive again," said Edward Moya, a senior market analyst with OANDA. "Tech giants that have lots of cash, good product cycles and earnings momentum are becoming strong buys again."

The July rally was fueled partly by a view that the Fed's efforts to tame inflation by softening demand are showing some initial progress.

"This selloff started because we were in the midst of uncontrollable inflation," said Callie Cox, a U.S. investment analyst at eToro. "Now, demand is slowing, and while that puts the economy in a rough spot, it could take care of the inflation crisis."

Even if July was not the end of the bear market, it could be a "taste of what a recovery could look like," Cox said. Still, if a recession is underway, layoffs, closures and lower profits will likely lead to further declines in equities.

"This recovery won't be easy, and for now, the Fed hasn't finished the job on inflation," Cox said. "There could be another shoe to drop."

Choppy waters

While the consumer discretionary and information technology stocks rallied the most in July, they remain at steep losses on the year.

A prolonged market rally will still leave the highs well below the all-time peak in early January. Data from two jobs reports and a pair of consumer price index releases will largely determine whether the Federal Open Market Committee will implement another steep raise in interest rates at its next meeting in September.

The S&P 500's July performance was only a "premature pivot party," Mike O'Rourke, chief market strategist with JonesTrading, wrote in a July 31 note, since it seemed to anticipate that the Fed had turned dovish while it could tighten policy even more in months to come.

"This story has some way to run," said Michael Hewson, chief market analyst with CMC Markets. "Until we see evidence that inflation is peaking then the current bout of volatility is likely to continue."