With the US market now having rallied 17% from its mid-June lows (after a 24% correction), there is considerable debate as to whether the current rally is merely a bear market rally, or whether the rebound represents a more durable turning point into a new bull market phase.

While we are keeping an open mind (and a close eye on the data), our base case is that this rebound represents more than just a bear market rally.

Central to this view is that US inflation has now hit a major downward inflection point that will allow the Fed to halt its tightening cycle before year-end, and to ease policy some time next year. This should allow the US to avoid a genuine recession in 2023, limiting the downside for 2023 earnings.

Our inflation view is based on both an easing in consumer demand as the US economy slows and an ongoing improvement in the global supply chain. We expect inflation to fall significantly over the coming year.

We are cognizant that bear market rallies are relatively commonplace, so a 17% rally in itself is not a clear signal that a fresh uptrend is under way. Bear market rallies tend to occur in prolonged bear markets, which occur during long recessions when investors’ hopes for an end to the bear phase are repeatedly dashed.

Typically, valuations are cheap at turning market points and sentiment is very negative. It could be argued that the market bottom in June did not meet those 2 criteria, particularly with respect to US market valuations.

We do not think the fact we never achieved bargain basement valuations in the US rules out the prospect of a durable market low. The low will hold if there is truly a sustained shift in what were the core drivers of the selloff - that is, inflation truly rolling over, bond yields tracing out a genuine peak, and the US economy achieving a softish landing.

However, the lack of genuinely cheap valuations in June may well mean that 12-month returns from the low are not as strong as typically seen in previous cycles.

We will continue to focus on US inflation as our key bull versus bear market indicator. Economic activity data remains an important secondary focus, with a not-too-hot, not-too-cold tone to such data likely to be the most favorable scenario over coming months. In particular, some easing in tight labor market conditions would be welcomed by the Fed. The tenuous situation in Europe and China continue to represent wildcards, but we agree with the market’s current view that these remain containable risks.

We stick with a neutral to marginally overweight position in equities, and an overweight in growth focused alternatives. We may be due for a near-term consolidation as equity markets digest the recent sharp rally before stocks move higher later in the year.

Australia looks relatively appealing on a 6- to 12-month basis, with reasonable valuations and lower recession risk. We do have some reservations regarding the Australian market’s medium- to long-term prospects, given the skew to banks and (iron ore) miners. We think investors will need to be reasonably active over the medium-term.

While our base case macro view is constructive, our return expectations are reasonably moderate. Uncertainty is still elevated, so we continue to seek diversification outside of equities. We removed our large fixed-interest underweight in late-June, following the big lift in yields, and we now see bonds in a range trading pattern.

Inflation hedges (e.g., infrastructure) are appealing in a risk-return sense as they should do reasonably well if inflation proves sticky. However, if inflation eases and growth slows significantly, the defensive nature of infrastructure cashflows will provide support. Domestic floating-rate credit also continues to appeal as cash rates rise.