Lets go back in time a bit. On the morning of March 24th, 2000 – the Nasdaq 100 (QQQ units) kissed $120 a share, and the S&P 500 (SPX) hit 1550. By the eve of 9-11 August the following year the QQQs were 66% lower, near $40. The SPX neared 990, about 36% lower. Was that it for the bear? Nope. After all that pain, the NASDASQ units went on to lose another 50% to bottom at $20 on October 9th, 2002! The SPX declined about 20% more to around 780. Finally, it reversed in October 2002 with a classic hammer reversal candle. The SPX chart below paints the picture. The lesson here: After the bear´s initial mauling, investor sentiment is so wounded and jaded – any follow-on bad news triggers the final flush! I like to call this stage “capitulation”. All hope is lost, and all hideouts (low beta stocks, etc.) are surrendered in the final act of a true bear market. Today’s blog addresses the question: are we at the market bottom yet? Or is that final bit of bad news to trigger the capitulation flush still to come?
Earnings season is upon us
With the S&P toying with the vital 3600 level at todays close, and bearish sentiment and short interest near extreme levels, we keep getting the classic 4-7% two-to-three-day bounces with no follow-through. The SPX rallied through 3600 in an atmosphere of “FOM” (Fear of Missing Out) early last week. Only to retreat right back to that key support zone today. Will 3600 hold? I believe that the current earnings season will have something to say to us about that potential. In fact, it will not surprise me at all to see 3600 fail. Lets explore that potential:
To start: Third-quarter S&P 500 earnings growth is now expected to be 2.6%, down from 9.8% in July, according to FactSet. Analysts have cut profit forecasts by $34B and, if the consensus is correct, it would be the worst quarter for bottom lines since Q3 2020, according to the Financial Times.
However – sentiment is bearish – which is a good thing. According to the latest MLIV Pulse survey, more than 60% of investors believe this earnings season will push the S&P 500 lower.
Another “however”….BlackRock recently noted it thinks earnings estimates still look “optimistic.” It (like ValueTrend) remains underweight equities, stating that valuations have not come down enough to reflect weaker earnings prospects. Perhaps Blackrock is noting the historical trend for earnings to decline fall 15%-20% in recessions.
Rising rates, falling earnings. The case for a pivot, and a bear market bottom
While interest rates will likely continue rising for at least the near-term due to the Federal Reserve’s determination to crush inflation, there is enough evidence to suggest them peaking and then likely to begin falling sometime in 2023. Here’s why:
- The Fed’s current rate policy will see inflation continue to decelerate in the final months of this year (especially when stripping out energy costs) and reach into the mid-single digits.
- We are likely headed for a recession (if not in one already). Even the FED and the BOC have admitted this (finally). As inflation numbers begin to fall meaningfully, and economic pain becomes more prevalent, the FED and BOC feel the heat from both Wall Street/ Bay Street – and Main Street – to reverse course and cut interest rates again. Remember – ordinary people have 401K’s (USA) and RRSP’s (Canada). They are watching their savings decline, their real estate values plummet, and their buying power deteriorate. This creates a pullback in spending – which feeds the recession. Its called the wealth effect. This negative wealth effect will push the banks to move rates to stable or down. Well before their unrealistic 2% targets are approached.
- The prior ridiculous non-GDP accretive massive deficit spending (corporate bailouts, college loan forgiveness, gender studies, sending money to Africa, etc, etc), added massively to existing debt for NA governments. This results in higher interest payment costs which, combined with the growing defense burden that China’s rise and Russia’s aggression is demanding, will force spending more money than they can afford to collect in taxes without destroying the economy. As a result, NA governments, having painted us into this hole, will have no choice but to continue borrowing and printing more money. It is logical to assume that this will keep inflation higher than the 2% target. Yet, the FED & BOC will be under pressure to keep interest rates as low as possible in order to service their ballooning debt.
Lets assume that rates on both sides of the border hover around 4% for the foreseeable future. This will likely be at or below the inflation rate. So – higher inflation than we’ve been accustomed to over the past 20 years – higher rates than we’ve seen for some time. As I have noted on this blog too many times to count – commodities should continue to deliver strong returns in the coming years due to these factors. Indices like the S&P 500, and the TSX 300, being capitalization-weighted, will be rebalanced to reflect the higher performance of commodity producers.
So, the bull market will return – but with different outperformers than the technology stocks of the recent bull market.
How to spot the bottom
As I’ve noted ad-nauseum, we need to see the SPX hold 3600. This week could be the make or breaking point. It barely held 3600 at today’s close (Monday OCT 10).
If it does not hold, and we get a final washout (as addressed in the opening of this blog), we can expect a selloff to one of the support levels noted in my recent blog “The Worst Case Scenario“. A piece of bad news, as noted in my opening comments, could cause that final capitulation flush. Unless that’s already happened, meaning that the recent tests of 3600 were “it”. Don’t predict. Do prepare. Be open to any potential. Your opinion does not matter. Nor does mine. Support on the charts is all that matters. We’re in an elevator. Each support level represents a floor. Problem is, we don’t know which floor this elevator is programed to bring us to. Don’t predict. Do prepare.
Here’s the chart from that blog. My noted support levels are 3600, 3200, 2950, 2500 for the SPX.
No two market cycles are ever exactly alike, and markets never behave in exactly the same way. But human emotion is about the most stable market force out there, and people generally react in a similar way to price action. Based on how they’ve behaved in recent months, we’re getting to a point of discouragement, if not washout. Case in point: My Bear-o-meter reading, which highlights sentiment/emotion indicators in its mix, recently moved up from a “0” score to 2.
Still, ValueTrend has not budged with the high levels of cash held in our models. The fact is that the SPX remains below its 200 day SMA, below its last rally-high, and the Bear-0-meter remains in the higher risk zone. This is still a risky environment. There’s room for a possible final washout to one of the support levels noted above. That’s not a prediction. Its a potential. All I am saying is – the time isn’t here for ValueTrend to trigger a buy with our cash. So far, our discipline has kept us away from the head-fake rallies of this year. Our clients are safe. The good news is, its getting closer for the real bottom to appear. And that means, if you have been listening to my suggestions and raised cash this year, you’re in good shape to earn substantial upside when that time arrives.
This week will be enlightening. Stay tuned!