Are you impressed by the recent rally for the S&P 500 (SPY)? Steve Reitmeister explains why this could be another sucker rally for the next leg down. This is especially true as we come to the next Fed meeting on Wednesday, June 14. Get Steve’s updated market outlook, trading plan and top picks below.
Last week’s stock breakout is now consolidating just under 4,292 for the S&P 500 (SPY)…the level that indicates a new bull market. This leads to serious sector rotation that can often be quite confusing when you dive into the details.
So it’s better to back off to see the big picture, which is exactly what we’ll be doing in this week’s Reitmeister Total Return commentary.
First, let’s clarify why 4,292 is such an important level for stocks. That’s because the official definition of a new bull market is that the S&P 500 closes 20% above its lowest closing price.
We go back to October 12e we see that the bottom was 3,577.03. Now add 20% to that equates to stocks needing to close above 4,292.44 to be technically called a new bull market.
On Tuesday we ended at 4,283.85. Close … but no cigar.
What has emerged this week is a period of consolidation for the S&P just below this key level. But beneath the surface, there is a DRAMATIC sector rotation.
For example, on Monday, small caps hit the mat after a strong top cut to the chin. Then on Tuesday they even outperformed the large caps 10x (no typo).
What does it mean? Nothing!
Consolidation periods are best valued as a “just wait” period when investors are not ready to move up…nor are they willing to really back out. As a result, the overall market average hardly moves on a daily basis. However, there can be big differences between winners and losers between sectors and market cap groups.
The reason this kind of action means nothing is that if you’re trying to chase the sector rotation in search of trading gains, you’ll almost always miss the action… like a dog chasing its tail. Just tired and confused.
Investors are better off using their time to determine what happens AFTER the consolidation period is over. As in, will we break higher to confirm the new bull market or are we ready for a serious correction?
There are 2 keys to predicting that outcome. First, what will the Fed do at their next meeting on 6/14. Second, what are the chances of a recession forming and rekindling bearish sentiment.
Let’s start with a discussion of the upcoming Fed meeting on Wednesday, June 14e. Right now, investors see a 78% chance that rates will not be hiked, consistent with many of the Fed’s recent official statements.
Before you hail this as the long-awaited pivot to more accommodative policies, remember that investors expect a 51% chance of a 25-point gain at the July meeting. And another 11% expect this to be a larger 50-point increase.
Clearly, the Fed has consistently said there is more work to be done to bring inflation back to the 2% target. And so you shouldn’t expect lower rates until 2024 with the goal of lowering demand (aka slowing down the economy to slow down prices).
Please don’t forget that Powell still stated at the May meeting that their base case scenario pointed to a recession on its way before their work was done. I don’t think his tune will change at the June meeting, which will likely again throw cold water on the bulls at the 6/14 announcement.
Now let’s move on to the second topic that will weigh heavily on the market outlook. That’s if there’s a recession ahead that wakes the bear from its recent hibernation.
Just roll back two paragraphs to realize that the Fed expects a recession before all is said and done with their rate hike regime. Next, consider this recession forecast I noted last week from famed Swiss money manager Felix Zulauf:
“We don’t know when the recession started until after the fact, but there is an indicator that you can watch that gives you an indication of when the recession has started, without knowing for sure. And that’s when the inverted yield curve starts to decline planes.
“And actually we’ve seen a flattening of that yield curve over the last few days or two weeks, and this could be an indication that we’re very close to the onset of a recession.”
And here’s a correlated chart showing the 2 year vs. Shows 10 years of interest rate inversion over time and relationship with recessions (gray bars):
Indeed, you can see that the recession periods did not occur at the deepest moments before the yield curve inversion. Instead, it took place after it flattens out and often begins to improve.
Now keep that in mind as you look at the far right of the chart where the most recent inversion begins to level off. And tie that in with the expected 10% decline in corporate earnings in the second quarter. And now correlate that with the Fed’s expectations that a recession will set in by the end of the year before they start cutting rates.
Third, take a look at the recent deterioration in some of the most-tracked economic indicators, starting with ISM Manufacturing last Thursday. That was deeper in contraction territory at 46.9. As bad as that sounds, the forward-looking New Orders component of 42.6 says things are likely to get worse.
But Reity, manufacturing is only 15-20% of the US economy. What are the results of the much more meaningful ISM Services report?
That tumbled from the previous positive reading to an anemic 50.3, with the employment component in contraction territory falling to 49.2. This means service providers are more concerned about future growth prospects, forcing them to scale back their hiring plans.
If price action was your only guide, then there is indeed some cause for excitement as we are on the verge of a breakout in bull market territory. But when you understand the fundamentals, such as Fed focus on action and the current state of the economy, it becomes more difficult to expect more upside at this point.
My guess is that the consolidation period of just under 4,292 will extend until the Fed’s announcement on 6/14. So until then please don’t get caught up in all the sector rotation nonsense. It is better to prepare for what is to come.
On that note, I predict stocks will fall in earnest from the afternoon of 6/14 as investors are reminded of the committee’s vigilant plans to quell inflation once and for all (which will likely hurt the economy crush).
As they say “Don’t fight the Fed“.
So if they tell you flat out that we’re likely to have a recession before all is said and done, it’s best to take their word for it. Which means the stock is more likely to go lower from here…and probably a lot lower.
What to do now?
Discover my balanced portfolio approach for uncertain times.
This helps you participate in the current market environment and adjust more bullish or bearish if necessary.
This strategy has been developed from over 40 years of investment experience to appreciate the unique nature of the current market environment.
At the moment it is neither bullish nor bearish. Rather, it is confused and uncertain.
But given the facts at hand, we will most likely see the bear market come out of hibernation and pull stocks down again.
Fortunately, we can devise strategies to not only survive that recession…but thrive. That’s because with 40 years of investing experience, this isn’t the first time I’ve gone to the bear market rodeo.
If you’re curious to learn more and see the hand-picked trades in my portfolio, click the link below to get on the right side of the action:
Wishing you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return
SPY shares rose $0.24 (+0.06%) in after-hours trading on Tuesday. Year-to-date, SPY has gained 12.35% versus a percentage increase of the benchmark S&P 500 index 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 investing experience in the Reitmeister Total Return Portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.