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Why the Third Quarter Earnings Season Will Have a Big Impact on Where the Market Goes Next…

In last week’s commentary, we discussed the importance of the mid-June lows for the S&P 500 (SPY) and the possibility of an undercut and then a rebound. In many ways this is exactly what markets do -> frustrate the maximum number of bulls and bears. Sure, the bears were raving about this slump with many additions to shorts and puts, while many bulls likely capitulated. Now we are more than 5% above these lows. Next on the roll is the September jobs report tomorrow and a CPI report next week. These will play a big part in determining the path and nature of this bear market rally. In today’s commentary, I’d like to discuss some lessons learned from the past 2 bear market rallies and how we’re going to apply them to our portfolio. Read on below for more information….

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(Enjoy this updated version of my weekly commentary originally published on October 6th)e2022 in the Newsletter POWR Shares Under $10).

For the past week, the S&P 500 (SPY) is up 4.4%, though it had risen more than 6% at one point, before taking any gains in the September jobs report.

It was a broad rally with power across the board. Not surprisingly, we see the biggest moves in the most oversold sectors such as metals, energy and technology.

Why is the market rising?

Technically we have a double bottom especially with the drop below support and quick recovery. As long as this double bottom is intact, we must respect the bull box.

To be clear, this is a bounce. But given the strong technical stance and bearish sentiment, my gut feeling is that this is likely to evolve into a bear market rally that lasts for weeks and tests key resistance levels on the upside.

And if fundamentals develop in a supportive manner, the bear market rally could even make a little more sense. Every bull market started out as a bear market rally, but not every (or most) bear market rally turns into bull markets.

Again, I think we are on the same precipice. If this is a normal, cyclical recession, then buying at these levels will likely pay off in six to 12 months.

If this is more along the lines of 2002 or 2008, then stocks are probably in the middle innings of their descent. In that case, the S&P 500 will likely break 3,000 and we can see the retracement of the entire rally that started in March 2020.

Income and rates

So far, all of the market’s weakness can be attributed to inflation and higher interest rates pushing down multiples for the S&P 500 (SPY). That’s because earnings growth has remained positive despite the many headwinds facing the economy and mounting concerns about an imminent recession.

So the third quarter earnings season has only just begun and will play an important role in determining whether the rally can turn into a rally, or whether it will turn quickly. To lead the way, analysts predict earnings growth of 2.9% for the third quarter.

This is a drastic cut from expectations of nearly 10% earnings growth in the third quarter from a few months ago. It is largely a result of warnings and guidance from companies that are lower given the many headwinds.

Objectively, it’s not bad. But it is an indication that the markets are expecting some pain, creating the potential for an upside surprise. And this is exactly what happened in the second quarter and was one of the factors behind the 18% rally for the S&P 500 between mid-June and early August.

On the interest rate front, there are some subtle developments that conflict with the latest CPI report, which sent short- and long-term interest rates to new highs.

Essentially, we see real estate prices falling, used car prices falling and freight prices falling, in addition to easing lower energy prices.

Just as the cyclical versus secular recession debate has major implications, the inflation debate is equally compelling and interesting. There is one camp that sees inflation as an onion.

Just because the outside is okay doesn’t mean the core isn’t rotten. Essentially, that core inflation is its own beast with only a mild connection to more volatile, cyclical factors.

The other side sees core inflation simply lagging behind more real-time indicators like the ones mentioned above. This camp believes that inflation has already peaked and that the core CPI is simply a lagging indicator.

Last 2 bear market rallies

Going back and studying the last 2 bear market rallies in 2022 is quite instructive.

Both posted double-digit gains in a short space of time and huge gains in the most oversold stocks and sectors. Certain sectors and stocks even managed to reach new highs.

In short, we need to take advantage of these rallies while also considering the endgame, especially if the fundamentals deteriorate.

These bear market rallies can help us identify which stocks and sectors are benefiting from secular trends versus cyclical trends. And that can really help drive outperformance during the next bull market.

For example, I notice incredible strength and accumulation in energy, lithium and alternative energy supplies. On the other hand, oversold stocks can be bought for trading and just for trading as they can flip and hit new lows.

What to do?

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First, because they are all low-priced companies with the most upside potential in today’s volatile markets.

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All the best!

Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Shares Under the $10 Newsletter

SPY shares closed at $362.79 on Friday, down $-10.41 (-2.79%). Year-to-date, the SPY is down -22.73%, versus a % increase in the benchmark S&P 500 index over the same period.

About the author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR growth and POWR Shares Below $10 newsletters. Read more about Jaimini’s background, along with links to his most recent articles.


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