Stocks Continue on Their Volatile Path

Stocks continue on their volatile path since hitting record highs at 4,500, says Steve Reitmeister, editor of Reitmeister Total Return.

Or to be more exact, this has been going on since the middle of March when the Russell 2000 made new highs (and now -5.6% below that level).

Why is this happening? And what should we do about it? The answers to those pressing questions and more are explored in detail below. Let’s to today’s commentary in Q&A style. I think this will be a good way to cover the key issues at hand.

Q: What is the main reason that stocks are down from the all-time highs?

A: There are actually many reasons that investors could point to at this time. None of which is truly a long-term bearish case. Just all semi-interesting reasons that would lead to this near-term pullback before the next leg higher. Here are those reasons in order of importance:

4,500 = Resistance: This is a pretty good milestone for the market that would naturally lead to a round of profit taking that culminates in a period marked by pullback or correction along with ample sector rotation. We saw the same thing happen at other major levels like 4,000. So, nothing truly ominous in this action. Just part of the markets natural ebb and flow.

Supply Chain Concerns: We haven’t talked much about this concept to date. However, it first came to my attention, not from the media, but from a good friend of mine who works in the factory automation industry.

Through his job at a leading S&P 500 company he has a pretty good purview into the state of the nation’s manufacturing sector. He recently told me point blank that he sees the potential for the supply chain constraints to cause a recession in the not too distant future.

Shortly after his comments I see the supply chain issue making it to the mainstream media. With all other economic indicators looking positive, this black swan type event to derail the economy is one to watch. Likely, because it is on enough people’s radars, the issue will be solved before it truly harms the economy. However, we owe it to ourselves to be mindful of this one because if it does worsen, then stocks will indeed head markedly lower.

Rising Inflation > Rising Rates: We have talked about this one many, many, many times in recent commentary. Even though there is good reason to believe that most of the inflationary pressures are transitory, you see acknowledgment from Fed chairman Powell, that it may be lingering around longer than previously expected.

This explains the Fed’s more hawkish views of late which the market is FINALLY appreciating through the movement of 10 year rates (up from 1.3% to 1.53% in the past couple weeks). Yet, here again, the historical facts are still quite bullish in the face of this news as spelled out.

Q: Reity, aren’t you worried about the debt ceiling?

A: That is a big, fat NO!

That’s because we have been to this DC Rodeo dozens of times before. They always make a last second deal and life goes on. Wall Street is quite aware of this “boy who cried wolf” routine and are not buying the fake cries this time around.

Q: So why are tech stocks so weak? 

A: Because a longer-term consolidation period like now comes hand in hand with sector rotation. The longer the consolidation goes on, the more likely you are to see just about every group getting rough treatment. Given that tech stocks have been so strong, for so long, then they have quite a bit of excess to give up during a sector rotation period.

No doubt this haircut for tech will culminate in an attractive “buy the dip” opportunity for the best names in the group. However, it doesn’t mean that EVERY tech stock will be attractive. It’s still prudent to have an eye towards the strength of their earnings outlook combined with reasonable valuations. Meaning that a stock that is overvalued by 50% and gets sold off by 20% is still quite overvalued and should be avoided.

Q: Does the economic outlook still support a bullish environment? 

A: YES!

During the past month there were some minor reports where results softened a touch. Thus, it was important to see how the vital national reports came out to start October. Gladly the economic report card is very impressive at this stage including a 61.1 reading for ISM Manufacturing on Friday coupled with an even more impressive 66.7 showing for the forward looking New Orders component.

Today we found out that the services sector is even more impressive as ISM Services rang up a 61.9 reading with 63.5 for New Orders. Both of these results were well above expectations.

Net-net, when added together, tells you the economy is humming right along and that should show up in the Q3 earnings reports that will start rolling out later this month.

Q: How about the technical picture of the market...how is that holding up? 

A: The last four sessions has put the 100-day moving average under strain. Yet we closed today clinging to the underside of that level.

Here are the updated key technical levels at this time:

4,440 = 50-day moving average

4,351 = 100-day moving average

4,144 = 200-day moving average

Q: Reity, what is your recommended trading plan at this time?

A: The long term outlook remains bullish with this current period being a fairly natural pullback period coupled with ample sector rotation. Thus, it says to keep our bullish bias in place.

Yes, stocks could go lower. And yes, the pullback could last longer. But just as well, it could bounce back with a vengeance at any time ready to make new highs above 4,500.

So unless we see greater concerns about the supply chain and potential negative effects on the economy, then I will keep fully invested expecting the bull market to kick back into gear sometime soon.

Often it is the proof of yet another positive earnings season that acts as a catalyst to remind people of the bullish elements at play. If true, then stocks will likely be heading higher before October comes to a close.

Closing Comments

The recent market sell off is not really based on any great concerns on the economic outlook. Just a natural break after a long bull run.

Simply stated a bull market doesn’t mean that stocks go up and up and up. Instead, it is about their being more up days than down days over time allowing the overall market to pull ahead.

So there will be short spans where the opposite occurs. The natural reaction to that is to rip of a longer bullish winning streak. When that starts is always a mystery. Thus, best to stay firmly long the market awaiting that day so you never miss an ounce of upside.

Learn more about Steve Reitmeister at StockNews.com.