(Please enjoy this updated version of my weekly POWR Value newsletter commentary).
Stocks have been hot since rising +18% from June lows. It’s really hot. Like standing on the hot sun.
So it’s easy to dismiss this week as nothing more than healthy profit taking as we enter a well-deserved period of consolidation.
This makes more sense as you appreciate that on Monday the S&P 500 (SPY) finally found resistance at the 200-day moving average (was 4,326, now a notch lower at 4,321).
This action has led to a period of consolidation and a trading range as the logical next phase for this market. Yes, to digest recent gains. But also to wait for the next catalyst to determine if the market is truly in a long-term bullish mood or if we are falling back into bearish market conditions.
As you’ll see from the title of my recent post, this gives me some guidance on what I see coming next. So be sure to read it now if you haven’t already as it covers a lot of important topics: 5 Reasons to Always Be Bearish.
One of the main themes of this article is that with inflation so high and the Fed so determined to raise rates, it’s hard not to appreciate the damage that will be unleashed on the economy.
This is likely why the majority of participants in a recent Goldman Sachs survey of investment professionals saw a recession unfold in the first half of 2023.
The release of the Fed minutes on Wednesday put further exclamation on the above as stocks sold off sharply, followed by much more pain on Friday.
Basically, the Fed plans to keep raising rates until inflation drops significantly. And with inflation this high… that means a lot more rate hikes to follow.
This should come as no shock to anyone, as they have spent most of the last month on the talk circuit telling anyone who will listen that they will continue to AGGRESSIVEly raise rates.
This is not a bullish idea. In fact, by its very nature, it aims to dampen economic activity as a means of controlling inflation.
So if it’s not bullish, is it bearish?
This is the key question that investors are trying to answer. Does that mean the Fed can raise rates just as aggressively and not create a recession and an extended bear market?
Possible…but not probable in my book, which is why I remain bearish.
Bond investors are clearly feeling the same way given the inverted yield curve indicating a recession likely to occur in the next 1-2 years. And now we’re waiting for stock market investors to see this with their own eyes in areas like weakening labor markets and falling corporate profits.
If and when these clues appear, we will revert back to previous lows in June…and likely lower.
Let’s talk about the corporate earnings portion as we come out of the weakest earnings season since 2020. That might come as a surprise given the rally in stocks over the past few weeks.
The best answer to this is that the expectations were so horribly low that it was easy to jump over the low hurdle.
What the image below shows is the erosion of the earnings outlook since the start of the earnings season on 7/1 until now. You will see that growth expectations have tapered for the next 3 quarters.
Most telling is how Q1-23 is approaching no growth, coinciding with the recessionary outlook noted above in the Goldman Sachs survey.
Now let me share with you the analysis that accompanies this chart by my friend, Nick Raich, at EarningsScout.com. (note its emphasis points in bold)
* Investors may be overly optimistic about the Fed’s ability to 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 of the S&P 500 EPS estimate declines is not over.
*One of the main reasons we think the worst estimate cuts aren’t over is that the S&P 500’s overall EPS expectations (i.e. multiple periods of quarterly and annual EPS estimates) only fell at a rate of -2.26%.
*To put this into perspective, overall expectations for the S&P 500 EPS were falling at a rate of -25% in March 2020 and at rates of nearly -50% in 2000 and 2008.
*For this reason, we expect EPS estimate reductions in excess of -3% to occur during the upcoming Q3 2022 earnings season, which will peak between mid and late October.
* Stay underweight.
Nick and I spent many years together at Zacks Investment Research, where we enjoyed the connection between earnings trends and stock prices. It is therefore very difficult for us to see the current estimate drop and not be cautious about our stock market outlook (SPY).
Worse still, further declines in estimates are likely to occur as the Fed rein ins the economy with higher rates. And that’s why it’s hard to accept the growing bullish sentiment right now.
For now, I see a period of consolidation with the formation of a trading range. The highs were found at the 200-day moving average (now at 4,321). And the low side is probably framed by the 100-day moving average (4,096).
All movement within this range is meaningless noise. This includes the Friday sale. Investors are waiting for clear and obvious indicators to know if we are really ready to enter a new bull market. Or if the bear market is still in charge with a likely return to June lows, or even lower to follow.
My bet is on the bearish argument to come out on top. Yet ready to objectively review information as it comes in and turn bullish if necessary.
Many new people are joining POWR Value this week. And so no doubt, you will probably find the above comment confusing given that we have a portfolio full of many stocks. So let me spell it like this…
Think of most mutual funds or ETFs you have purchased. All of them have written goals, which are basically 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 achieve long-term stock price appreciation.”
And come rain or shine, this fund will stick to the target, no matter if investors turn away from small caps. It doesn’t matter if this is the worst bear market in human history.
I believe newsletters should basically work the same way. And in the case of POWR Value, I seek to find the most profitable stocks, regardless of market conditions.
The only difference with the fund example is that I allow the portfolio to not always be 100% invested. In fact, right now we’re only 43.5% invested…but that will go back up to 50.5% when I add the next pick on Monday morning.
The fact is that this heavier allocation to cash is a nod to market conditions which I believe are still quite bearish.
For those who want more of an active trading, market timing element to their portfolio, be sure to check out how I run my Reitmeister Total Return service.
There, the objective includes market timing and the ability to go short if necessary. Right now, my solution for the emerging consolidation period and the trading range is a balanced hedged portfolio with inverse ETFs and a handful of my favorite stock positions.
In fact, it worked spectacularly last week as the market hit recent highs.
Fortunately, the POWR Value approach has also worked spectacularly so far, simply by having a higher percentage of cash when things were tough, as well as the continued outperformance of our picks with the benefits of the POWR rating system. .
As of tonight’s close, the S&P 500 fell -11.28% on the year, while the POWR Value portfolio happily reversed that frown with a modest gain.
In short, there is more than one way to attack today’s market conditions. I’m undoubtedly proud of what we do with POWR Value…but if you’re more interested in the Reitmeister Total Return approach…then make sure you get access here.
What to do next?
Check out my hedged portfolio of exactly 10 positions to help generate gains as the market drops back into bear market territory.
This is not the first time I have used this strategy. In fact, I did the same at the start of the Coronavirus in March 2020 to generate a return of +5.13% the same week the market fell almost -15%.
If you are fully convinced that it is a bull market…then feel free to ignore it.
However, if the bearish argument shared above has you curious about what happens next… then consider getting my “Bear Market Game Planwhich includes details of the 10 positions in my hedged portfolio.
Click here to learn more >
I wish you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
Reitmeister Total Return & POWR Value Editor
SPY shares closed at $422.14 on Friday, down -$5.75 (-1.34%). Year-to-date, SPY is down -10.46%, versus a % rise in the benchmark S&P 500 over the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience 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, plus links to his most recent articles and stock picks. After…