A report card for the stock market as it approaches one year since the October 2022 bottom of the mini-bear market would probably read, “Good effort, shows perseverance, needs improvement.” In the broadest statistical terms, the S & P 500 has maintained the uptrend that began last Oct 12 with a close of 3577 after last week nearly touching, never breaching, and then bouncing off its rising 200-day moving average near 4200. The index now sits 20% above its low close of last year, which qualifies as a good 12 months in the abstract but places it at very low end compared to first years of other bull markets. .SPX 1Y mountain S & P 500, 1-year As put by Doug Ramsey of Leuthold Group, who has been skeptical of the staying power of the advance, “The rally from last October’s low represents either the longest hibernation of any bear in stock market history, or a bull that’s so feeble it should still be considered a calf.” The feebleness can be gauged by the constantly cited unevenness of the market. The equal-weight S & P 500 is up less than 12% from its low. The median stock in the index is up between 3% and 4% over the past 12 months. The small-cap Russell 2000 has buckled below its 200-day average and is down slightly year to date. The mega-cap-growth proxy Nasdaq 100 last week essentially recaptured its relative peak versus the equal-weight S & P 500 from the summer of 2020, at the height of the stay-at-home Covid liquidity-rush boom. This top-heavy performance profile understandably comes off to many investors as unstable and perhaps unrepresentative of what the “real” market is up to. Fair enough, but it’s not irrational. The projected earnings growth of the largest growth stocks has roared higher over the past several months, compared to a slight upturn among the rest of the index. And these companies generate a great deal of cash, are net beneficiaries financially from higher yields and aren’t tethered tightly to every feint in GDP growth. At the same time, the rest of the market has grown cheaper as rising perceived recession probabilities and higher capital costs weigh them down. Stephen Suttmeier, technical strategist at Bank of America, finds evidence that such divergences are not poor omens in the short term. He looked back at years when S & P 500 was leading the Russell 2000 by at least ten percentage points through the third quarter, as is the case this year. All four times since 1979, the S & P 500 and Russell 2000 were both higher in the fourth quarter. Can stocks live with yields at these levels? The internal struggle of the market is hard to spin as a positive in itself. Still, it has come against some strong opposing currents that the majority might have expected would sink the index entirely. Since the October 2022 low, the Fed funds rate is up by 3.25 percentage points and the 10-year yield is up from 3.9% to 4.8%, a sharp move even more jarring for having occurred in just the past two months. There was a sudden regional-bank failure in there, too, which threatened a broader credit crunch that has yet to take hold. Against these forces we have a steady trend of ebbing inflation and a bottoming and anticipated re-expansion of corporate earnings. Not to mention AI excitement and new miracle weight-loss drugs. Jurrien Timmer, director of global macro at Fidelity Investments, says: “The stock market has been in limbo for a long time. That can’t last forever—what does? It could end with a whimper or a bang. “The bang would be the long-awaited recession, a final washout for equities, and then a typical early cycle recovery, in which the ‘worst’ stocks (those with cyclical earnings and weak balance sheets) recover the fastest and the market broadens out. “The whimper scenario would be a soft landing with inflation falling below 3%. That could be enough for the Fed to take its foot off the brakes, while earnings estimates continue to improve, driven by an AI-led boom in capital investment.” He notes that with the short-term policy rate now well above core inflation, the Federal Reserve has room to “give back” some recent rate hikes at some point next year without appearing to be panicking over the economy. But that scenario is a fair distance and several blind turns away. For now, the urgent question is whether the real economy and equities can make peace with yields at current levels. Under the right conditions, a 4.8% 10-year Treasury is digestible. Nominal GDP growth is running above that level, let’s remember. Friday’s strong headline payrolls report implied that labor demand is still solid and wage disinflation intact, even if Wall Street will remain on high alert for signs that consumer fatigue, credit stresses and pressure on housing will at some point stall out the economy. The market pullback has drained some valuation risk out of equities. The S & P 500 is now at 17.7-times 12-month forward profit forecasts, according to FactSet, down from almost 20 in late July. It’s standard to caution that stocks appear richer than average on this basis, though only over the longest span does valuation drive returns. Five years ago, the index’s forward P/E was 16.8. Annualized total returns the past five years are 10%. Three years ago, the P/E was a steep 22 and the index has returned 10% annualized since then too. Over the past decade, the yearly return was 11.8%, the P/E having started that decade under 15-times expected earnings. Earnings season kicking off Earnings season does get rolling this week, and Deutsche bank points out economic-surprise metrics were positive the entire third quarter, implying standard upside-surprise dynamics will be in play. Stocks in general have traded poorly off even better-than-forecast numbers in recent quarters, so we’ll have to see if the recent weakness of the majority of stocks since mid-summer has lowered the bar sufficiently. The 1.2% S & P 500 rally Friday showed the market able to respond, reassuringly, to widespread oversold conditions and an upwelling of pessimistic sentiment, after the 10-year Treasury yield tested and then retreated from the week’s high. The jump did break the index above its little three-week downtrend, though technically it probably won’t qualify as more than a reflex oversold bounce unless it gets decisively back above 4400, another 2-3% gain from here. It would be pretty textbook, if also a bit trite, if this two-month turbulence turned out to be another routine 8% pullback in the S & P to the 200-day average, culminating in another decent tradable low just as the seasonal tailwinds are due to arrive in mid-October. Even if a typical late-year rally takes hold, which would get the index back to its July high, it’s hard to envision investors confidently breaking out of the late-cycle psychology which sees expansion-ending ghosts around every corner. The character of the past year’s advance surely leaves plenty for the market to prove. Yet those doubting that a benign economic outcome is possible over coming quarters also face a burden of proof, as did the bearish consensus of October 2022, which foresaw a stagflationary trap and declared the Nasdaq critically wounded.