The stock market rally has room to run and investors should start taking on more risk, Ned

• Investors should start to take on more risk and buy consumer discretionary stocks, according to Ned Davis Research.
• The research firm said several indicators suggest the current stock market rally will continue.
• “We will likely take another step towards growth [stocks] on additional model confirmation,” NDR said.

In the first half of 2022, growth stocks’ pain was value stocks’ gain, but now that trend is set to reverse as the stock market extends its rally off the June 17 low.

That’s according to Ned Davis Research, which said in a Thursday note that investors should start to take on more risk as “several indicators suggest the rally could have room to run.”

Those indicators include buy signals in NDR’s internal Big Mo Tape and another round of breadth thrusts, which track momentum and occur when a high percentage of stocks rally together.

A string of strong technical breadth thrusts suggests momentum is building across various sectors, improving the chances that the stock market will continue its move higher.

“The sector model … now favors growth sectors over value sectors for the first time this year … we will likely take another steps towards growth [stocks] on additional model confirmation,” NDR said.

To express its view that now is the time to take on more risk, NDR upgraded the more volatile consumer discretionary sector to overweight at the expense of more defensive sectors like utilities, healthcare, and materials.

The top two holdings in the consumer discretionary sector are Amazon and Tesla, and their recent outperformance is suggesting that the sector is poised to continue higher, according to the note.

“Both [Amazon and Tesla] are now nearing relative golden cross signals that have been consistent with strong outperformance by consumer discretionary, historically,” NDR said.

Ultimately, NDR concedes that the continuation of the stock market rally will hinge on the Federal Reserve’s ability to orchestrate a soft landing in the economy. But there are more signs today than a couple weeks ago that it remains a possibility. 

Inflation is cooling off as oil prices fall, evidenced by July’s CPI report and recent import/export price data. Meanwhile, the housing market is showing signs of sticking a soft landing despite higher mortgage rates. All-in, this could give the Fed more flexibility in slowing down its interest-rate-hike trajectory.

But if inflation doesn’t fall, all bets are off.

“If inflation fails to meaningfully fall and the Fed must remain aggressive throughout the year, the risk of a Fed-induced recession will grow… [and] defensive leadership would be expected to return,” NDR concluded.