Bull Or Bear Market? The Battle Begins.

Inside This Week’s Bull Bear Report

• Bull or Bear Market
• The Bullish Case
• The Bearish Case
• How We Are Trading It
• Research Report – Why Long-Term Returns Are Unsustainable
• Stock Of The Week
• Daily Commentary Bits
• Market Statistics
• Stock Screens
• Portfolio Trades This Week

Bull Or Bear Market? Who Is Right?

Bull or bear market. As noted last week, the race to call the bottom is on.

“Despite the Fed hiking rates, shrinking their balance sheet, and inflation at 9%, much of the financial media and market gurus have determined that the bear market is over and a new bull market has started.”

However, as we will review this week, there is data supporting both bull or bear market arguments. The challenging part for investors will be navigating the markets safely over the next few months until the “tale is told.” Before we get to the bull or bear market analysis, let’s review the action from the past week.

While the markets were consolidating recent gains over the last week or so, the weaker-than-expected CPI print on Wednesday, as expected, sent stocks surging. While the print came in softer than expected, the annual inflation rate remains very high, keeping the Fed focused on the “inflation fight” for now. Notably, the high inflation levels, which won’t come down quickly, will eat into corporate profit margins over time, leading companies to take on more defensive tactics to maintain profitability.

Ira Jersey, via Bloomberg, had one of the most relevant statements regarding inflation:

“Our analysis shows that the lower-volatility (read sticky) components of core CPI may have peaked in July, but the medium-volatility sector continues to jump higher. If the low-volatility cluster stabilizes at this higher level, these combined trends may keep core CPI underpinned and the Fed hawkish…. The better-than-expected core CPI print will be a strong positive for the Treasury market, particularly the long end, so the knee-jerk reaction is unsurprising. The strong steepening of the curve may not last, however, as the better-than-expected core still doesn’t mean it will fall. In fact, although better than expected, the core may be sticker than the market seems to be anticipating.”

However, in the short-term, the softer CPI reading emboldened the bulls on hopes the Fed may be closer to the end of its rate hiking campaign, potentially paving the way for future cuts. There is a bullish bias to the market, with sentiment improving sharply in recent weeks. With the market clearing the 100-dma and the 20-dma crossing above the 50-dma, precise short-term support levels will provide better entry points for increasing trading positions. While the market is pushing a rather extreme deviation above the 50-dma, the 200-dma is acting as a magnet for investors, which will likely be achieved next week.

However, the question that we will debate today is the longer-term bull or bear market view.

The Bullish Case

Much of the bullish case is predicated on the hope the Federal Reserve is closer to reinstating monetary accommodation. As Jim Paulsen of Leuthold Group noted this past week:

“Wow, finally the anecdotal evidence that inflation was easing has finally showed up in a mainstream inflation report. The Fed is rapidly losing its case for further tightening and this report reinforces for investors that either a new easing cycle has already begun or we are getting very close to one.”

The market rally over the last couple of weeks was based upon the anticipation of “peak inflation.” Importantly, as we touched on last week, several bullish indicators suggest the market’s lows may be in. On a weekly basis, the shorter-term MACD signals have triggered a buy signal from a very oversold basis. Historically, that signal suggests higher prices over the intermediate term.

But an even more bullish chart comes from a monthly perspective. As shown, the market decline bounced solidly off of the 3-year moving average. Such is an essential point as it tells us that the current decline was a “correction” and not a “bear market” since the market did not violate bullish price trends. Notably, as shown at the bottom, the monthly relative strength index (RSI) also bounced off the 50% level, which is consistent with previous “corrections.” (RSI tends to correct below 30 during bear markets.)

Lastly, there are several non-technical reasons the market likely has some additional strength and could rally further:

1. There is still a sizeable level of short interest that will need to cover as prices rise.
2. Earnings estimates are getting rapidly cut, leading to improved “beat rates” in the Q3 earnings period.
3. Retail investors are jumping back into the markets.
4. Institutions remain offside with too much cash on their books and a need to chase performance.
5. Volatility has declined rapidly as “fear” of a correction fades.
6. Credit spreads continue to fall as money returns to the yield chase.

There are undoubtedly many rationales to the bullish case for equities. With financial conditions easing, as stocks rally and credit risks ease, there is a bid for equities in the short-term. The technical backdrop also suggests that the lows are in, and investors should buy corrections.

However, is this time different? That is where the bull or bear market debate finds its argument.

The Bearish Case

As is always the case, the bearish argument is grounded more in the macroeconomic, monetary, and financial fundamentals. While the bulls are ramping up equity risk in hopes of a “Fed pivot,” there is little indication from the Fed that such is likely anytime soon. In fact, from a historical perspective and even recent comments, the Fed’s focus is singular on bringing inflation down to its 2% target. As noted, even if CPI prints at 0.2% every month, it will take until the end of 2023 for inflation to decline to the Fed’s target.

Furthermore, the Federal Reserve is not keen on running a $9 Trillion balance sheet. The Fed needs the Fed Funds rate to be elevated and the balance sheet reduced to engage those policy tools to offset the next recession. Equities are at risk as the Fed’s inflation fight will trigger a recession. We can “review the tape” of the 1970s to see that bear markets and recessions were common when the Fed was hiking rates and combating inflation.

However, when it comes to equity risk it is corporate earnings that will drive equity prices. As the Fed hikes rates to slow economic activity and potentially cause a recession, such will translate into slower earnings growth and reduced profit margins. Given that valuations are near 30x earnings currently, such suggests that stocks will need to reprice lower. The 6-month annual rate of change of the Leading Economic Index (LEI) supports that thesis, suggesting earnings will decline over the next two quarters.

Whether the bull or bear market view wins out will only be found out in time. However, as noted, while the bulls currently control the technical picture, the Fed still has control of the macro environment. While we will continue to trade the markets tactically in the short term, in our view, there is still a risk of a more profound decline unless the Fed changes course in short order.

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How We Are Trading It

The short-term market environment is indeed bullish. As such, we are looking to increase equity exposure on tests of support that work off some of the overbought conditions. Those supports range from the 100-dma down to the 50-dma, keeping the short-term uptrend intact. The 20-dma is set to cross above the 100-dma next week, increasing that support level as a potential buying opportunity.

To reiterate from last week, the current market environment remains very challenging. We remain highly vigilant to the current climate where the bulls cling from one report to the next in hopes of a reprieve from the Fed. However, we suspect such won’t come soon, and the risk of disappointment remains elevated. But, as always, we remain focused on what the market is telling us.

One area we added exposure to this week was Energy. After the recent correction, which we discussed was likely back in May, the oversold condition, a weakening dollar, and fundamental backdrop to higher energy prices made a compelling case to add to our energy holdings. Concerning technology, we will take advantage of any opportunity where the 50-dma is tested and holds as new support.

Even with our current changes, we maintain a substantial cash holding. We will work to lower that cash holding as opportunities present themselves.

Over the last couple of weeks, we have repeated the portfolio management rules. With extended markets, now is the opportunity to:

• Sell losers and laggards.
• Trim winners back to portfolio weights
• Rebalance allocations
• Hold cash for opportunities

Patience remains vital in navigating this market. Try not to let “FOMO” direct your investment strategy.

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Research Report

Stock Of The Week In Review

In the Bull Bear Report, we will post one of the stocks from our research at SimpleVisor to find stocks worth taking a deeper look into. The 5-For-Friday report is published each week in full for SimpleVisor.com subscribers.

This week we limit our population of potential stocks to those in the materials sector. The sector includes a diverse group of companies that mine, harvest, and produce raw materials used by many other industries.

Within the materials sector, we are looking for dirt cheap valuations alongside a history of solid earnings growth and strong…