S&P 500 was in the bear market territory after falling more than 20 percent from its recent highs. That was in June when the market saw a lot of stocks tumbling down from their peak valuations. July trading session closed with one of the best performances witnessed in a long time after the market jumped more than 7 percent.

But, is that a bear market rally that the market saw in July or the momentum is sustainable? The fed rate hikes are still not over and the impact of higher rates is yet to come out in open on the company’s earnings and the economy.

Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley shared his views when the S&P 500 moved above the 50-day moving average in the last week of July. Wilson’s reading of the market may provide direction to the investors and traders looking to navigate the stock market volatility.

Excerpts

Since the June lows at 3650, the S&P 500 has been range trading between those lows and 3950. However, this past week, the S&P 500 peaked its head above the 50-day moving average, even touching 4000 for a few hours. While we aren’t convinced this is anything but a bear market rally, it does beg the question is something going on here that could make this a more sustainable low and even the end to the bear market?

First, from a fundamental standpoint, we are more convicted in our view that S&P 500 earnings estimates are too high, and they have at least 10% downside from the recent peak of $240/share.

So far, that forecast has only dropped by 0.5%, making it difficult for us to agree with the view that the market has already priced it. Of course, we could also be wrong about the earnings risk and perhaps the current $238 is an accurate reflection of reality.

However, with most of our leading indicators on growth rolling over, we continue to think this is not the case, and disappointing growth remains the more important variable to watch for stocks at this point, rather than inflation or the Fed’s reaction to it.

Having said that, we do agree with the narrative that inflation has likely peaked from a rate of change standpoint, with commodities as the best real time evidence of that claim. We think the equity market is smart enough to understand this too, and more importantly, that growth is quickly becoming a problem. Therefore, part of the recent rally may be the equity market looking forward to the Fed’s eventual attempt to save the cycle from recession. With time running short on that front.

And looking at past cycles, there’s always a period between the Fed’s last hike and the eventual recession. More importantly, this period has been a good time to be long equities. In short, the equity market always rallies when the Fed pauses its tightening campaign prior to the oncoming recession. The point here is that if the market is starting to think the Fed’s about to pause rate hikes after this week’s, this would provide the best fundamental rationale for why equity markets have rallied over the past few weeks despite the disappointing fundamental news and why it may signal a more durable low.

The problem with this thinking, in our view, is it’s unlikely the Fed is going to pause early enough to save the cycle. While we appreciate that investors may be trying to leap ahead here to get in front of what could be a bullish signal for equity prices, we remain skeptical that the Fed can reverse the negative trends for the demand that is already now well-established, some of which have nothing to do with monetary policy.

Furthermore, the demand destructive nature of high inflation is presenting itself today will not easily disappear even if inflation declined sharply. This is because prices are already out of reach in areas of the economy that are critical for this cycle to extend in areas like housing and autos, food, gasoline, and other necessities.

Secondarily, high inflation provides a real constraint for the Fed to pause or pivot, even if they decided the risk of recession was imminent. That’s the main difference versus more recent cycles and why we think it remains a good idea to stay defensively oriented in one’s equity positioning until further earnings disappointments are factored into consensus estimates or equity prices.