The nearly 20% bull run from the March lows is over. Now it's time to rest up in a trading range for the next run higher, states Steve Reitmeister of Reitmeister Total Return.
Meaning this is the natural course of things. To relax after a hard run...and then store up the required energy for the next sprint. The best part is how we can use these more range-bound periods to buy the dip on some stocks with terrific upside potential. Let's talk about how we will do just that in this week's Reitmeister Total Return commentary.
We FINALLY saw the stock market take a step back after a seemingly non-stop five-month rally. Many investment commentators point to the Fitch ratings downgraded of US debt as the primary cause. However, if we are being honest with ourselves....this sell-off was long overdue. The Fitch announcement was just a convenient excuse to hit the sell button for a while. Friday was an interesting session worthy of note. The Government Employment Report seemed like a Goldilocks announcement. Not too hot...not too cold...just right helping the S&P 500 rise nearly 1% early in the session.
Yet as the day progressed those gains melted off the board leading to a -0.53% session. Even more interesting was closing below 4,500 and now probably on our way towards 4,400 (more on that in the Price Action section below.) Even though we don’t like seeing red on the screen...this is healthy. Investors took the opportunity of an intraday rally to take more gains off the table. On Monday we got a solid bounce back as investors have gotten into the habit of buying every dip the past several months as that strategy has paid off handsomely. What they didn’t know was a surprise announcement on Monday that Moody’s was downgrading their ratings on a slew of small to midsized banks. This reawakened the Risk Off sentiment from last week with more investors hitting the sell button in earnest on Tuesday.
This is the classic swinging of the fear/greed pendulum. The greed of the rally up to 4,600 was overextended. Simply conditions were not that pristine to keep rising. This left investors vulnerable to any bad news for which Fitch and Moody were reminders that the overall market may be ahead of itself. Another reminder of this is on the earnings front. As we come down the homestretch of Q2 earnings season we find that earnings estimates for the future have been trimmed for the next few quarters. Adding those 3 quarters together points to virtually no year-over-year growth.
The Weak Earnings Outlook Is Not Good Fuel for a Bull Rally
Especially true when the S&P 500 is already at a PE of 20. That is not necessarily overpriced...but it is rather fully priced. Thus, to reasonably expect more upside you need better earnings growth prospects for the future to compel higher prices without overly inflating PE. This is a long way of saying that now is a logical time for the runaway rally to end and for us to enter a healthy consolidation period to digest recent gains. And thus be more selective about the stocks that should advance from here.
So Why Still Believe in a Long Term Bull Rally?
Because the Fed is providing more hints of a “dovish tilt”. That gained steam with the speech from Harken of the Philly Fed where he stated that likely no further rate hikes are needed. At this stage, they just need to give the current high rates time to sink in and bring down inflation further. Then start thinking about lower rates. Plain and simple, the future lowering of rates is a tailwind for the economy that increases the odds of better growth prospects (what is needed to push prices higher). Knowing that is on the horizon is a reason to be more bullish now. On top of that, you have more business people feeling optimistic about the future. Here is the chart for the NFIB Small Business Optimism reading on Tuesday morning at 91.9.
As you can see this is the third straight month of improvement and the highest reading in quite a while. This increased optimism is a precursor to improving growth trends. Think about this. First, you feel good about something...then you act on that positive impulse. This is why sentiment surveys are considered leading indicators of future economic activity. Putting it all together there is stronger reasons to believe that recession will be avoided during this rate hike cycle. If so, then the economy should pick up from here...which lifts earnings prospects... and is a necessary fuel for share price appreciation.
Price Action & Trading Plan
Here is the updated S&P 500 chart:
Moving Averages: 50 Day (yellow), 100 Day (orange), 200 Day (red)
Right now 4,600 is setting up as a spot of stiff resistance and now trying to find support on the underside for likely a trading range to form. I guess that the 50-day moving average of around 4,420 is about as low as stocks need to go. This sets up for a trading range where we likely swim around for a few months before the typical holiday rallies of November/December kick in giving us a real shot at the previous all-time high of 4,818. This sets us up nicely for a stock pickers market which is my favorite. Meaning that the overall market is kind of lukewarm...but those with a stock-picking advantage find a way to carve out profits. In our case, the POWR Ratings are a big advantage in our corner to find stock-picking profits in any market environment...especially an environment where the leaders are overripe and investors will rotate to more attractive, underpriced plays.