The 4 week winning streak for equities ended on our sour note on Friday. Not only did the S&P 500 (SPY) plunge -1.29%, but recent market leaders have had even worse results: -2.07% for Russell 2000 and -2.01% for tech-laden Nasdaq. What does this mean for share prices in the coming days? And do we return to bear market conditions? That will be the focus of this week’s commentary. Read on below for more….
(Enjoy this updated version of my weekly commentary from the POWR Value newsletter).
Stocks have been hot since they surged +18% from the June lows. That’s really hot. Like standing on the hot sun.
So it’s easy to see this week’s sell-off as nothing more than healthy profit-taking as we enter a well-deserved consolidation period.
This makes sense because you appreciate Monday’s S&P 500 (SPY) eventually found resistance at the 200-day moving average (was 4,326, now down a notch at 4,321).
This move led to a consolidation period and trading range as the next logical stage for this market. Yes, to process recent gains. But also to wait for the next catalyst to determine if the market is really in a long-term bullish mood or if we are slipping back into bear market conditions.
As you will see from the title of my recent article, it gives my hand on what I see coming. So make sure to read it now if you haven’t already, as it covers a lot of important ground: 5 reasons to still be bearish.
One of the main themes in that article is that with this high inflation and the Fed so determined to raise interest rates, it’s hard not to appreciate the damage that will be unleashed on the economy.
This is probably why the majority of participants in a recent Goldman Sachs survey of investment professionals saw a recession emerging in the first half of 2023.
The release of the Fed Minutes on Wednesday added further exclamation to the above as stocks sold strongly, followed by much more pain on Friday.
In fact, the Fed plans to keep raising interest rates until inflation declines significantly. And now that inflation is so high… it means many more rate hikes will follow.
This shouldn’t come as a shock to anyone as they have spent most of the past month on the speaking circuit telling anyone who will listen that they will continue to raise rates AGGRESSIVELY.
That’s not a bullish idea. In fact, it is naturally intended to curb economic activity as a means of taming inflation.
So if it’s not bullish, is it bearish?
That is the main question investors are trying to answer. Does this mean the Fed can raise interest rates so aggressively and not cause a recession and bear market expansion?
Possibly…but not likely in my book, which is why I remain bearish.
Bond investors clearly feel the same way, given the inverted yield curve that points to a recession likely to happen in the next 1-2 years. And now we’re waiting for equity investors to see for themselves in areas such as weakening labor markets and lower corporate earnings.
If and when those clues emerge, we’ll return to the previous June lows…and likely lower.
Let’s talk about corporate earnings, as we’ve had the weakest earnings season since 2020. That may sound surprising, given the number of stocks that have risen in recent weeks.
The best answer to that is that expectations were so shockingly low that it was easy to jump over the low threshold.
What the image below shows is the erosion in the earnings outlook from the start of the earnings season at 1-7 until now. You will see that the growth expectations for the next 3 quarters are declining.
Most telling is how the first quarter of 23 has almost stopped growth, which coincides with the recession outlook mentioned above from the Goldman Sachs survey.
Now let me share with you the analysis that came with this chart from my friend, Nick Raich, on EarningsScout.com. (note his bold accents)
* Investors may become overly optimistic that the Fed will win the battle against inflation without hurting future growth.
* They may also be too hopeful that the Fed will start cutting interest rates in 2023.
* Our research indicates that the worst cuts in the S&P 500 EPS are not over yet.
* A major reason why we think the worst estimate cuts aren’t over yet is that overall S&P 500 EPS expectations (i.e. multiple periods of quarterly and annual EPS estimates) are only falling at a rate of -2.26 %.
* To put that in perspective, overall S&P 500 EPS expectations fell -25% in March 2020 and nearly -50% in 2000 and 2008.
* For this reason, we expect a decline in earnings per share of more than -3% in the upcoming 3Q 2022 earnings season, peaking in mid-to-late October.
* Stay underweight equities.
Nick and I both spent many years together at Zacks Investment Research, where we appreciated the link between earnings trends and stock prices. So it is very difficult for us to see the current estimate fall and not be careful with our stock market (SPY) outlook.
Worse, there are likely to be further declines in estimates as the Fed slows the economy down with higher interest rates. And that’s why it’s hard to agree with the growing bullish sentiment right now.
For now, I see a consolidation period where a trading range is forming. The highs were just found on the 200-day moving average (now at 4,321). And the low is likely to be framed by the 100-day moving average (4,096).
Any movement within this range is meaningless noise. That includes the sale on Friday. Investors are waiting for clear and obvious indicators of whether we are really ready to break out into a new bull market. Whether the bear market is still in the lead with a likely return to the June lows, if not lower.
I’m betting on the bearish argument to emerge victorious. Still willing to objectively assess the information as it comes in and turn bullish if necessary.
Lots of new people are join POWR Value this week. And that is why you will no doubt find the above comment confusing as we have a portfolio filled with many stocks. So let me spell it out like this…
Think of almost any mutual fund or ETF you’ve ever bought. They all have written objectives, which is essentially a mission statement that they live by.
In the fund world, it would be something like “This fund focuses on small-cap growth stocks to drive the stock price up over the long term.”
And come rain or shine, that fund will stick to its target regardless of whether investors turn away from small caps. It doesn’t matter if it’s the worst bear market in the history of mankind.
I believe that in principle newsletters should work in the same way. And in the case of POWR Value, I try to find the very best value stocks regardless of the market conditions.
The only difference from the fund example is that I allow the portfolio to not always be 100% invested. In fact, we’re only 43.5% invested right now… but that will go up to 50.5% when I add the next pick on Monday morning.
The point is that this heavier allocation to cash is a nod to market conditions that I believe are still quite bearish.
For those who want more of an active trading, market timing element in their portfolio, be sure to check out my Reitmeister Total Return Service.
There, the target includes market timing and the ability to go short when needed. Right now, my solution for the emerging consolidation period and trading range is a hedged portfolio balanced with inverse ETFs and a handful of my favorite stock positions.
In fact, it has been working spectacularly well over the past week as the market has bounced off recent highs.
Fortunately, the approach for POWR Value has also worked spectacularly well so far, just by having a higher percentage of cash when the going got tough, along with the continued outperformance of our picks packed with the benefits found in the POWR Ratings -system.
As of tonight’s close, the S&P 500 is down -11.28% over the year, while the POWR Value portfolio has happily turned that frown on its head with modest gains.
Long story short, there is more than one way to attack current market conditions. I’m no doubt proud of what we do with POWR Value…but if the Reitmeister Total Return approach appeals to you more…make sure you get access here.
What to do?
Discover my hedged portfolio of exactly 10 positions to help generate profits if the market falls back into bear market territory.
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 return of +5.13% in the same week the market plunged close to -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.
SPY shares closed at $422.14 on Friday, down $-5.75 (-1.34%). Year-to-date, the SPY is down -10.46%, 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.
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