Are equities likely to continue their summer rally?

What's next for equities?

After July’s market rally many investors are likely wondering what is next for equities?

Historically, when markets are trapped in a bear market there are often rallies that make investors feel like it’s the right time to buy, before being trapped once again in a selloff.

If we look at both charts of US indices and European indices we see the same technical pattern - a sustained break above a key area of resistance. As mentioned, this is not uncommon to see and usually precedes another downturn.

But the performance in July has been quite something, with most indices managing to achieve a follow-through to the initial reversal. This has likely left many investors feeling like it’s the right time to buy again, but is that the case?

Well, in other instances when market sentiment has taken such a sharp turn during a bear market, it has usually involved central banks cutting rates and loosening monetary conditions. This hasn’t happened yet, and will likely not happen for a while, but markets seem to be very convinced central banks will start cutting soon and are therefore trying to front run the market. This is likely going to be a costly mistake if it turns out to be another rally within a bear market.

The belief that inflation has been handled and the key focus of central banks is aiding economic health has likely been the cause of many of those who think the lows in June were the bottom of the market.

But the Federal Reserve (Fed) has in fact reiterated that bringing price stability is more important than avoiding a recession in the US, a key takeaway that seems to have been overlooked.

We have also seen the central bank abandoning forward guidance and focusing on incoming data to make its policy decision, meaning there is likely more volatility up ahead for equities.

We’re also seeing companies cutting their growth forecasts and warning about staff cuts, which will in turn lead to a weaker third quarter (Q3), something investors don’t seem to be considering.

Technical outlook: S&P 500 and the DAX 40

The technical outlook for both the S&P 500 and the DAX 40 is still showing the longer-term trend to be bearish.

Despite having broken above key resistance at their respective descending trendlines, the momentum over the last two sessions is showing buyers are struggling to find further upside in the short-term. This means that both the S&P 500 and the DAX 40 could start to return to their longer-term bearish trend over the next few days.