The S&P 500 (SPY) rose 18% from its June lows until hitting a wall in mid-August. At first it looked like the reason was simply hitting the resistance level on the 200 day moving average. But really, if we’re honest with ourselves, it’s the reawakening of the negative outlook for the economy. We can all thank Fed Chairman Powell for writing it on the tablets handed over from Mount Jackson Hole. So where do stocks go from here? And what is the best trading plan right now? Read on below for the answers.
One of the most confusing things for investors to spin their heads around is the correlation between the current economic picture and the movement of stock prices.
When the economy is looking good and the market is falling, it seems counterintuitive. The same goes for the darkest hour of a bear market, as stocks begin to rally while the economy is still in dire straits.
This is one of those times when investors are a little confused by the contradiction between the apparently healthy economy and the red arrows in stock prices. So let’s cover this hot topic in today’s commentary.
After the first close under 4,000 on Tuesday, there really is a “battle for the soulof this stock market. First on Wednesday, bulls took the lead, rushing back more than 4,000. Then the bears clawed back tick by tick. Finally, the S&P 500 (SPY) fell again on Wednesday to close at 3,955.
Yes, there was a small rebound for the S&P on Thursday… but “Risk On” positions were knocked out, as shown by the -1.15% shown for small caps in the Russell 2000. So, record another session for the bears with yet it was a third straight under 4,000.
And then on Friday, bigger early gains were washed off the board to close more than 1% at 3,924, marking the fourth straight week of losses. Most technical analysts would call that a confirmation of the break below 4,000 as it moves from support to resistance.
All this recent negativity seems rather odd as there are some clear positives in the economy. As many as 315,000 jobs were added in August to keep up with healthy employment trends. We could talk about many other individual economic reports showing growth, but it’s best to focus on the GDP picture for the US as that takes everything into consideration.
The Atlanta Fed’s recently updated GDP Now estimate for the third quarter has just increased to +2.6% after a solid result for ISM Manufacturing. This is in stark contrast to the pain that was levied on stocks that same day as they fell further below 4,000.
This brings us back to the theme mentioned in the intro: How can we explain the stock’s recent weakness in light of solid economic results?
The simple answer is that investors are always looking ahead. Like what’s probably around the corner so they can make adjustments before it’s too late.
Remember that most of the money in the market is invested by professionals. Not individuals.
While you and I can go from 100% long to 100% short in just a few minutes in our online brokerage accounts. The same is not true for professionals who often have to manage billions of dollars. Some have such large holdings, concentrated in just a small pool of stocks, that if they sold them too quickly, their actions alone would shrink the stock.
This explains why they have to look ahead. So they can devise strategies to make major shifts in their portfolios that could take weeks or months.
So, what are the pros predicting now?
Inflation is still too high and will not fall any time soon. Add to that a VERY aggressive Fed pounding the table that they will continue to raise rates through 2023 and it will cause economic PAIN.
Those who didn’t understand this basic equation were told this last week from the mountaintops of Jackson Hole, whose stock prices have since plummeted. This means that investors have received the memo.
Note that everyone had this memo in their hands in May/June, but somehow lost it during the outrageous and nonsensical July/August rally. Now it’s taped to their monitors again.
The message is also being received on Wall Street as earnings estimates for the first quarter of 2023 have been cut to just 3% earnings growth. Even worse Q2 of next year actually has no growth. This is a far cry from the 10-15% earnings growth we’ve had in recent quarters.
Also take a look at the sharply falling commodity prices of the past week. Oil is moving from a recent high of $95 a barrel to $88 in just a week.
That is NOT about current supply and demand dynamics. This is definitely about speculators looking ahead to future economic conditions and making their money out of these trades because an impending recession does = lower future demand, what does = lower prices ahead.
This same song is also sung in corporate suites. According to recent surveys from The Conference Board 77% of CEOs believe that recent economic conditions deteriorated in the second quarter. That’s more than 61% who felt that way when surveyed in Q2. Even more bleak: only 7% predict continued growth in 2023.
If executives predict a recession… it probably becomes a self-fulfilling prophecy. That’s because their negativity leads to caution in managing their business, which leads to a lower tolerance for spending or investment in the business. The more companies that exercise caution, by definition equate to lower economic activity and a greater chance of a recession.
OK… the outlook has deteriorated… So what’s the trading plan NOW?
I’ve been at the bear market since the end of May. That looked great initially as equities finally plunged into bear market territory in mid-June. But then there was a 2 month detour through an 18% bounce that bordered on criminally insane.
Since then, stock prices have returned to rationality by falling again amid the ominous economic outlook. In my last comment I was talking about a fork in the road that looked like 50% of the stocks remained in a range over 4,000. And a 50% chance of falling back into bear market territory.
Over the next few days, the latter argument wins with stocks clutching lower and lower. At this stage, the next logical support level is on the old battlefield of 3,855 for the S&P (SPY). That’s the line that marks a 20% drop from the January highs, which we all appreciate is bear market territory below that level.
That 3,855 level would be a good point for investors to pause and think about what comes next. With such high pessimism among both consumers and businesses, we will most likely continue to roll into recession over time and a commensurate bear market will unfold.
Just a reminder that the average bear market equates to a 34% drop from the highs. That points to 3,180, which is well below the current level.
Of course, with any average, there is a wide range of possible outcomes. This could be a milder bear… or a little more ferocious. But I have a feeling we’re going to hit the bottom somewhere in the 3,000 to 3,200 range.
If true, it means you need to prepare your portfolio for more price drops.
What to do?
Discover my hedged portfolio of exactly 10 positions to help generate profits if the market falls back into bear market territory.
And yes, it finished firmly in the plus column again this Friday, even as the S&P crumbled.
This is not my first time using this strategy. In fact, I did the same at the start of the Coronavirus in March 2020 to generate a +5.13% return in the same week the market collapsed -15%.
If you are completely convinced that this is a bull market… just ignore it.
However, if the bearish argument shared above makes you curious about what happens next… consider my “Bear Market Game Planwhich contains details of the 10 positions in my hedged portfolio.
I wish you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, Stock News Network and Editor, Reitmeister Total return
SPY shares were up $0.71 (+0.18%) in after-hours trading Friday. Year-to-date, the SPY is down -16.80%, versus a % increase in the benchmark S&P 500 index over the same period.
Steve is better known to the StockNews public as “Reity”. Not only is he the CEO of the company, but he also shares his 40 years of investment experience in the Reitmeister Total Return Portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock selection.