Spoiler alert…the bear market is not over. Unfortunately history shows that the S&P 500 (SPY) has much further to fall to squeeze out excess valuation. That is just a natural part of the bear market process that is properly explained in this timely market commentary. More importantly, this commentary provides a strategy on how to profit in the days and weeks ahead as the market finds its way to bottom. Read on below for more.
(Please enjoy this updated version of my weekly commentary from the Reitmeister Total Return newsletter).
Anyone who has kids…or has ever been a kid, knows the famous expression that happens on all long car rides:
Are we there yet?
Indeed that is the question on every investors mind to appreciate when we have arrived at bear market bottom and when it’s time to feel safe again.
So yes, we have been in the car driving south since January. Unfortunately, even with a lot of miles under our belt…and another recent bounce in hand, we are not there yet. Not even close.
That will be the focus of this week’s Reitmeister Total Return commentary…
As an important preamble, I want to make sure that everyone is up to speed on my most recent thinking on my bearish stock market outlook…proof the bear is here…how much lower will we go…and basic trading plan to profit on the way down while preparing to buy bottom when the time comes. All that and more is available in my most recent stock market outlook presentation.
Now let’s pick up the conversation from there…
Low rates is the oil that lubricates the economy to run faster. That is why lowering rates is the #1 tool of the Fed to help the economy during times of turmoil.
That is because in a lower rate environment it becomes very more and more attractive for businesses to borrow money to expand their businesses. That is why we often call the steps by the Fed to lower rates; “accommodation” as it accommodates a faster growing economy.
So what happens when you start doing the opposite…when there is less accommodation?
I think you know the answer. The opposite happens.
That’s because borrowing become less attractive. And thus less money circulates through the economy which equates to less spending and lower economic activity. But the more you ratchet up lending rates…the more likely you are to kill off borrowing which leads to recession.
The reason to not get bullish right now is that we are still too early in the process to squeeze excess valuation out of stock prices. That process normally takes 13 months to unfold with an average drop for the S&P 500 (SPY) of 34% from the previous highs.
Yes, every bear comes in different shapes and sizes. But when we discuss what comes next you will appreciate why there is more time and more downside to come.
At this stage all we have done is all we have seen is share prices drop and a deceleration in the economy (bordering on recession). But still Wall Street analysts have not yet trimmed their earnings outlooks for the future.
When they do that…then immediately valuations for stocks go up. And that increased valuation will also have to be removed before the bear market is over.
Let’s break that part down because it’s not intuitive on the surface. Right now Wall Street analysts are still predicting $231 in earnings per share for the S&P 500 (SPY). At today’s price level of 3,821 that equates to a PE of 16.4.
Yes, that is more reasonable than the 21.4 peak PE for stocks back in January. But it is still above the historical average of 15.5. And typically stocks go well below the historical average in the final stages of the bear market cycle before the next bull emerges. So even without any forthcoming lowering of earnings estimates, stocks are still a shade too elevated to call it bottom.
Now let’s say that Wall Street analysts finally get the memo that indeed this is a recession coming and start the process to lower future earnings estimates. Well the average recession comes with a 26% reduction in earnings outlook. I would guess this one will be on the milder side. So lets go with 20% reduction.
That would bring down estimates from the current to $231 to only $185. Given today’s closing price that would have PE ratcheting back up to 20.7.
Your eyes do not deceive you. Valuations will have basically have gone back to nearly the starting line like when we were at peak levels forcing investors to drive down prices to get PE more in line.
Note that this idea of lower EPS is not really a hypothetical. Nick Raich of EarningsScout.com gave this somber note this very morning:
“Here is the bad news: Our research indicates that 2H 2022 S&P 500 EPS expectations are likely to be cut by -15% to -25%.”
To be clear Nick worked with me for many years at Zacks Investment Research where we focused on earnings trends. And now he is considered one of the foremost experts on earnings trends getting him on CNBC, Bloomberg, WSJ on a regular basis.
Meaning when he talks about earnings…you should listen.
The point is that as the bear market rolls on the pendulum will keep moving farther and farther towards fear. That will mean that investors will have to squeeze down the PE to more reasonable levels that would encourage more value investors to step forward thus starting the bottom fishing process which begets the next bull run.
Now look at the totality of what we just discussed. If indeed there is a recession coming (which looks more and more likely by the day…heck, even Cathie Wood admitted as much today) then it is too early to call bottom pointing out the falsity of the recent rally.
Another way to think about this…the average bear market last 13 months. It takes time to work it all out of the system with a series of plunging to new lows…hefty rallies that make you question if bottom has been found…and then tumbling to yet lower lows.
Right now we are almost at the 6 month mark. No it wont magically last exactly 13 months. But I think you appreciate that process to squeeze out excess valuation is not yet done which is why we keep our bearish bias in place. And why I am not getting suckered into joining rallies like this recent one that seemed impressive only to get back on the selling track this week.
Right now there are ONLY 2 paths to making money. And no cash is not one of them unless you would like to lose 8% a year to inflation. What you need to do is…
Short stocks as the market heads lower (for which we have 4 attractive positions)
Short bonds as rates rise thanks to high inflation and hawkish Fed (for which we have 2 attractive positions)
This strategy pumped up our portfolio by +2.06% Tuesday while the S&P 500 (SPY) tumbled -2.01%. And now imagine how well we will do as stocks continue on their downward path likely towards 3,000 when we will start talking about some bottom fishing.
What To Do Next?
Right now there are 6 positions in my hand picked portfolio that will not only protect you from a forthcoming bear market, but also lead to ample gains as stocks head lower.
Like the ample gain in June as the market finally tumbled into bear market territory.
This strategy perfectly fits the mission of my Reitmeister Total Return service. That being to provide positive returns…even in the face of a roaring bear market.
Come discover what my 40 years of investing experience can do you for you.
Plus get access to my full portfolio of 6 timely trades to not just survive…but thrive in this brutal bear market environment.
Wishing you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, Stock News Network and Editor, Reitmeister Total Return
SPY shares rose $0.35 (+0.09%) in after-hours trading Tuesday. Year-to-date, SPY has declined -19.26%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.
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