Why have stocks risen from October lows and more investors turned bullish? But why have many bears refused to throw in the towel? What is it they see in the coming months pointing to lower lows for the S&P 500 (SPY)? Let’s take a look at the updated bull-bear debate, including how best to trade this tricky market environment.
There are signs that things are improving on the inflation front. And yet there are signs that the economy is getting worse.
This contradiction creates a very confusing gumbo for investors to digest. And probably explains why we continue to falter at 3,855 on the edge of bear market territory.
Let’s talk about these competing themes and how it has created 2 different scenarios for the stock market outlook. A bullish and a bearish.
I share which scenario is most likely and what it means for our trading plan in this week’s Reitmeister Total Return commentary.
Let’s start with the Fed’s game plan, as clearly laid out in Chairman Powell’s Jackson Hole speech in August:
- This is a protracted battle to bring inflation back to the 2% target
- DO NOT expect lower Fed rates until 2023
- To expect “economic painwhich was further described as below trend growth and weakening employment.
Let’s not forget that this speech quickly sobered up investors who enjoyed a summer rally of 18% to 4,300 for the S&P 500 (SPY). A month later, we made new lows below 3,600.
The Fed cherishes clarity and consistency in their communications. And that’s why I’m saying that any investor who thinks there’s going to be a meaningful policy change announced Wednesday, just a few months after Jackson Hole’s speech, is smoking something that’s still quite illegal.
Still, bulls do have something to cheer about, such as clear signs of declining inflation. Nearly all major commodities are far from their peak this year. The Bloomberg Commodity Index shows that the price trend is improving.
This moderation in inflationary pressures is fueling hopes that the Fed will not raise interest rates as aggressively in the future… and thus cause less damage to the economy as a whole. This has some people called the bottom, leading to the strong October rally (and hoping for the start of another bull market).
On the other hand, commodity prices are only part of the inflation picture. Don’t forget the “stickierelements such as house prices and rents. Even more important is wage inflation. That caused a JOLT in the wrong direction on Tuesday morning (pun intended 😉
See below the trend of job openings tracked in the monthly JOLTs report. For the past 5 months it has been a downward trend which means there were fewer job openings… indicating that hopefully there will be less wage inflation going forward. That’s why the jump in that report was greeted with an immediate sell-off in stocks Tuesday morning, as it rekindled inflation fears.
Coinciding with the JOLTs report was the release of ISM Manufacturing. As expected, that continues to move closer to recession levels with a reading of 50.2 with a forward-looking component New Orders notched down at 49.2. (Under 50 = shrinkage)
Here are some of the key statements captured by ISM to go along with the Manufacturing report to provide color commentary on what’s happening now and what it means going forward (bold by me for emphasis):
- “Customers cancel some orders. Stocks of finished products are increasing. Expect some rebound as some customers may be waiting for raw material prices to drop (further).” [Chemical Products]
- “The increasing threat of a recession is causing many customers to significantly delay their orders. In addition, global uncertainty over the Russia-Ukraine (war) is affecting global commodity markets.” [Food, Beverage & Tobacco Products]
- “We’ve seen a general decline in our clients’ available capital budgets, which has a significant impact on our revenue in the fourth quarter.” [Machinery]
- “Customer demand has been slower for two months. Production reduces our inventory and (we) execute forecasts carefully. The headwind seems to be very strong, so we have to be prepared for that.” [Fabricated Metal Products]
- “International circumstances loom and look very ominous. Overall, we still think 2023 will be a positive year, with at least some moderate growth.” [Nonmetallic Mineral Products]
- “Improve lead times. Plastic prices are falling.” [Plastics & Rubber Products]
- “Prices continue to fall slightly. Suppliers are trying to stop declines, but competition is increasing.” [Miscellaneous Manufacturing]
Just-just these statements reiterate the main point of my commentary today. Those are clear signs that the economy is slowing down. But inflationary pressures are also easing.
Now let me add one more element to consider before coming to my final conclusions. See the negative trend for the S&P 500 (SPY) earnings outlook as we are now more than halfway through the quarterly earnings season.
This data shows a general decline in earnings estimates for the coming quarters. In particular, you will see that Q1 and Q2 of 2023 are now expected to end with negative growth. This corresponds to a growing number of economists pointing to a recession in the first half of 2023.
These statistics were compiled by Nick Raich, who went on to say that Wall Street is far too optimistic about the outlook. This means that the full measure of the estimates cuts is not yet visible and we therefore recommend clients to expect more downward pressure on stock prices until we see more of the typical 15-20% loss of profit associated with recessions.
Now we come to the tricky part. That is to determine the most likely scenario in the future.
Scenario 1: Inflation is declining faster than expected, leading to less overall Fed intervention and creating a soft landing for the economy. In this case, it is not unreasonable to say that we have reached the bottom of the market and that a new bull market is emerging.
Scenario 2: We have already opened Pandora’s box with the economy. Once the wheels are in motion to head toward a recession, the economy can go through a vicious circle that grinds lower and lower. In this case, the bear market is still in play with a bottom likely closer to 3,000.
Which scenario is correct?
I think Scenario 2 is much more likely and why I remain bearish. However, Scenario 1 is a possible outcome that should be closely monitored.
Until investors are convinced which scenario is correct, expect increased volatility as we have seen this past week. Heck, Tuesday alone was a prime example.
That’s where the market opens +1% and then immediately returns everything and then some after the JOLTs and ISM Manufacturing reports. Then it stuck like glue around 3.855 which is an interesting support/resistance level.
Remember, 3,855 is the bear market dividing line, representing a 20% drop from the all-time highs of 4,818. That’s as good a place as a tug-of-war over the future of the stock market.
Given the history, the probability of a soft landing is very low. Famous investor Mohamed El-Erian talks about the same in this new article: Chance of soft landing is “lean”.
Like El-Erian, my outlook is bearish. That’s why my portfolio is built to take advantage when stock prices fall.
However, I am sleeping with one eye open for the possibility that the soft landing scenario will prevail where I would like to switch to a more bullish stance.
Unfortunately, with the job market still too hot, that inflationary pressure will only keep the Fed on a warpath of rate hikes, which doesn’t bode well for the economy and stock prices.
What to do?
Discover my special portfolio of 9 easy trades to help you generate profits as the market descends further into bear market territory.
This plan has worked wonders since it kicked off in mid-August, delivering solid gains to investors as the S&P 500 (SPY) plummeted.
And now is a good time to recharge as we hit even lower lows in the coming weeks and months.
If you have successfully navigated the investment waters in 2022, don’t hesitate to ignore it.
However, if the bearish argument shared above makes you curious about what happens next… consider my updated “Bear Market Game Planwhich details the 9 unique positions in my timely and profitable portfolio.
I wish you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Right”)
CEO, Stock News Network and Editor, Reitmeister Total return
SPY shares traded at $384.97 per share on Tuesday afternoon, down $1.24 (-0.32%). Year-to-date, the SPY is down -18.01%, versus a % increase in the benchmark S&P 500 index over the same period.
About the author: Steve Reitmeister
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.