It feels even more like deja vu as the S&P 500 (SPY) is embarking on its 3rd bear market rally of 2022 with each taking place during earnings season. Despite a handful of high-profile misses, the Q3 earnings season has continued the trend of previous ones by coming in better than expected. Given the market’s oversold state and some bullish seasonals, as we begin Q4, this has been sufficient to send the market more than 10% higher over the last 2 weeks. As we covered previously, it’s difficult to predict an endgame for the rally as this depends on dynamic factors like economic data and earnings, but we can be certain of its outcome. In today’s commentary, I want to recap our strategy for the current environment and then do our monthly review of various market topics. Read on below to find out more….
shutterstock.com – StockNews (Please enjoy this updated version of my weekly commentary originally published October 27th, 2022 in the POWR Stocks Under $10 newsletter).
Over the last week, the S&P 500 (SPY) is up by 4%. And, it’s indeed confirmation of the bear market rally thesis vs a bounce as we easily exceeded the previous high.
In terms of sector performance, I think one development is the outperformance of small caps which are up 7% vs the Nasdaq which is up 2%. Of course, the major factor is the high-profile earnings misses of companies like Meta, Microsoft, and Google.
In contrast, the “market of stocks’ is holding much better as evidenced by the Russell 2000 and the performance of the median company in terms of beating expectations for the top and bottom line. Additionally, margins continue to remain much more resilient.
There also continues to be some evidence for a “soft landing’ as the labor market shows no signs of cracking and GDP came in at 2.6% on a preliminary basis.
Recapping Our Strategy
However, nothing has changed about my more bearish stance in the intermediate and longer term. In fact, any positive news for the economy and financial markets is just more bullets for Fed tightening.
Any strength in these areas is construed by the Fed as evidence that it’s not doing its job to a sufficient degree.
It’s kind of like the absence of pockets of excess and speculation in financial markets is evidence that the Fed has more room to stimulate.
We are in the opposite situation. As we have discussed in previous commentaries, the good news is bad, because its means a tighter Fed, and bad news is bad, because it means that earnings will decline.
So, we are going to use this temporary period of strength to slowly take some profits and shift into a more neutral stance.
Constructive Criticism
I would say the biggest flaw in my performance this year has been not recognizing how quickly gains in the market and individual stocks can vanish once the bear market reasserts itself.
I’m determined not to repeat that mistake this time. And, I think one key is to sell on the way up and to act quickly once the short-term trend breaks.
Market Topics
Energy: Here’s a reminder of what I said last week on this topic.
“Lately, we’ve seen some relief in terms of energy prices with supply coming back, while demand has been less than expected due to China. In fact, analysts estimate that China is consuming about 2 million barrels per day less than it would usually does.
At the same time, Russian oil continues to find its way onto the market.
There are also rumors of the US easing sanctions against Venezuela and allowing exports which could add another 500,000 barrels per day.
There were also reports of negotiations with Iran although these seem to have ended with no resolution and are unlikely to restart given the crackdown against protesters.
And, of course, we have OPEC+’s decision to cut production by 2 million barrels per day.
Another factor in the mix has been the SPR’s sales of oil which have put downwards pressure on prices. There have also been questions about when the US will become a buyer and replenish these holdings.
Usually, my reflexive stance is to be critical of governments and find fault in their actions. However, this is an exception. The US government is reportedly going to buy oil futures contracts at around $70 per barrel for 2025.
This will effectively put a floor on oil prices which will increase production and give producers more certainty about prices.
The bear market in oil has led to caution among oil producers who were burnt badly by investing aggressively following the 2008-2012 period when prices averaged above $100 per barrel. Many of these projects went bust or were money losers over the next decade.
Thus, this will lead to more certainty among producers and increase CAPEX. It’s also a rare win for the government which effectively sold oil above $100 and is buying it back around $70 while helping alleviate the supply-side issues.”
I just want to share my current summation of the matter – longer-term, I continue to see powerful factors on the supply side that are supportive of a multiyear, bull market. In the short term, I think these factors will be overwhelmed by eroding demand due to a brutal global recession.
Defensive Strategies: One limitation of this universe of stocks is the lack of places to hide during adverse market conditions. One strategy is to overweight cash which we have done for nearly the whole year. But, that’s really it.
Most stocks under $10 are quite speculative in nature and have limited institutional ownership which makes them more susceptible to deep declines during major selloffs in the market which are a routine part of bear markets.
In my POWR Growth portfolio, we have overweighted cash in addition to defense & aerospace and pharmaceutical stocks which are up double-digits (or close to it), while the market is down double digits since the positions’ inception.
Election: I do believe that one factor in the recent market strength are the rising odds of a Republican win. This would eliminate the chances of any fiscal stimulus over the next 2 years which is bullish in an inflationary environment.
However, it does increase the odds of gamesmanship over the debt ceiling which could rear its head as a threat sometime next year. But, the bigger point is that Republicans are currently favored to win control of the House and Senate.
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All the Best!
Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Stocks Under $10 Newsletter
SPY shares closed at $389.02 on Friday, up $9.04 (+2.38%). Year-to-date, SPY has declined -17.15%, versus a % rise in the benchmark S&P 500 index during 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 Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
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