Will the 2023 rally run out of steam?

Investors could be caught in a bear market trap

Theo Andrew

a brown bear with a black nose

Many of the worst-performing markets over the past 12 months have been on a tear so far in 2023 with equities and cryptocurrencies making up significant ground in particular.

Exchange-Traded Products (ETPs) tracking bitcoin and ethereum have enjoyed a strong start to the year, with the cryptocurrencies up 36.3% and 29% respectively, while their boost has seen thematic ETFs tracking the crypto sector deliver double-digit returns year to date.

Leading the way is the Global X Blockchain UCITS ETF (BKCG), which has returned 69.4% year to date, followed by the VanEck Crypto and Blockchain Innovators UCITS ETF (DAGB) which has seen returns of 63.3%, according to JustETF.

Elsewhere, the HANetf Grayscale Future of Finance UCITS ETF (GFOP) and the WisdomTree Blockchain UCITS ETF (BKCN) have returned 49.8% and 43.8% respectively.

Other themes are thriving too. Electric vehicle stocks have rallied with poster boy Tesla up 58.8% year to date, while shares in EV developer Faraday Future Intelligent Electric are up a huge 200% on the news it is set to start production in April.

Despite the bumper returns, many of these products are still licking their wounds following a harsh “crypto winter” and a sell-off in broad tech stocks, remaining substantially down on a longer-term basis.

Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, said while crypto has seen by far the largest turnaround the overall trend points to a recovery for stocks that were battered last year.

“Crypto has had by far the largest turnaround, but there is certainly a relationship between worst performers doing the best this year,” he said. “Investors will always have a mild case of missing out on the uptick and with some of these [crypto markets] being 80% down it seems like a worthwhile bet.”

However, the question on investors’ minds will be how long the rally can last given most are anticipating a recession some point this year.

A bear market trap?

Russ Mould, investment director at AJ Bell said investors must remain cautious, with much of the rebound attributed to signs inflation has peaked and the anticipation that interest rates will be lowered towards the end of the year.

“As the old market saying goes, and investors must still coolly assess whether this really is the start of the next bull market or merely another wicked bear-market trap that will catch out the unwary and inflict more pain upon them,” he said.

“Caution may be needed for two further reasons. First, it is very unusual for the leaders in the previous bull market to be market darlings second time around, people lose faith in them because they lose so much money in them.

“Second, these rallies could just be the latest bear market trap – and bear market traps hurt. After the technology bubble of 1998-2000 burst, there were no fewer than nine major rallies in the Nasdaq.”

A recent note by JP Morgan also suggested the rally in the markets so far this year may be short-lived.

It said recent equity inflows will “likely run out of steam” on an anticipated decline in earnings expectations and a rotation into bonds.

“The recent weakening of economic data and an anticipated decline in earnings expectations and weak full-year 2023 guidance are pointing to markets that are likely to move lower, in our view,” Marko Kolanovic, chief market strategist at JP Morgan said.

“Recent equity inflows are likely running out of steam, while pensions’ overfunded status could drive an increase in their reallocation from equities to bonds this year.”

He added a recession is “currently not priced into equity markets” with European equities and US industrials flat over the year, “trading as if the energy crisis, war, and sharp monetary tightening did not happen”.

According to Peter Garnry, head of equity strategy at Saxo, markets hit the buffers later this week with tech giants Apple, Amazon and Alphabet all reporting their Q4 earnings on Thursday.

Investors will also be watching the Federal Reserve later this week and Saxo said it could be possible for the Fed to “surprise on the hawkish side” as markets continue to price in an eventual rate-cutting campaign later this year.

“The Fed continues to object to the market’s expectation of an eventual rate-cutting campaign set to begin by later this year, and it may attempt to surprise somehow on the hawkish side after especially the latter part of the ‘higher for longer’ message from the Fed has been ignored,” it said.

“What does that look like? Difficult to say: a 50bps move would be bold but would come as a profound shock to markets.”

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