by Bryan Perry

August 23, 2022

Friday’s downbeat close took every sector lower, with the exception of healthcare. Friday was also the first session where there were no genuine attempts to buy the intra-day dip, but it was also a day where $2.3 trillion in equity-linked options expired. Some argue this removes a layer of support for the market, so the S&P hit up against its downward-sloping 200-day moving average, prompting technical selling.

Standard & Poor's 500 SPY Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Scores of analysts are waving red flags, saying this bear market rally has run its course, so “look out below.” But a broad look under the hood of the previous decisive move up for stocks off the June low reveals some strong underpinnings that suggest any forthcoming pullback should be well-contained.

Several leading semiconductor and semiconductor equipment manufacturers reported better-than-forecast sales and earnings plus bullish guidance for the third quarter and into 2023. It was thought by some high-profile Wall Street analysts that the chip sector was topping out as companies double ordered, and so demand from automakers, industrial producers, and consumer device makers would hit the wall soon.

Predictions of retail sales crashing due to inflationary pressures have not materialized. The latest retail sales report, released last Wednesday, showed that consumer spending persisted in July across most categories, aided presumably by some relief in falling gas prices. Excluding autos, retail sales were up +0.4% for July with online shopping and building materials for remodeling leading the way.

Retail Sales Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Second-quarter earnings season did not collapse in the face of a multi-year high for the dollar, rising labor costs, and soaring energy prices. According to FactSet Earnings Insight, 75% of S&P 500 companies reported a positive EPS surprise and 70% reported a positive revenue surprise. For Q3, 42 S&P 500 companies have issued negative guidance and 30 S&P companies have issued positive EPS guidance.

Looking ahead, analysts expect earnings growth of 5.8% for Q3’22 and 6.1% for Q4’22. For the full year, analysts see earnings growth of 8.9%. That’s not quite the stuff of recessions, but more a case of moving capital into the strongest sectors, as any resumption of the recent rally will likely be a very welcome event by cash-rich investors that missed the first rally because of gloom and doom voices in the financial media.

July’s Industrial Production was up 0.6%, well above the 0.3% estimate, with capacity utilization surging back up to 80.3%, fueled by strength in automotive assemblies. And weekly jobless claims fell to 250K from the 266K consensus estimate, underscoring the resilient labor market and demand for skilled labor that is more than offsetting layoffs from businesses that benefitted greatly from the first post-Covid surge.

What has frustrated investors most is that the market never provided the textbook capitulation “whoosh” lower that is supposed to define a true bottom. In fact, fear of such an event is dissipating with each week as the market firms up and investor sentiment moves from real fear to a more neutral stance.

There’s no question that this newfound confidence could be derailed just as easily as it surfaced six weeks ago, but investors already expect another rate hike in September; they expect the housing market to cool further, as it should following a torrid rally; and they expect the Fed to talk tough in Jackson Hole this week, so it’s hard to identify any major bearish catalyst that could throw the market a phantom left hook.

Current AAII Sentiment Meter Image

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Upward pressure on wages, coupled with relatively stable economic data, undergirds the notion that the Fed will have to keep raising short-term rates to counter rising core inflation in professional services, including rent, transportation, medical services, cars, recreation, clothing, and education. While there has been some relief in gasoline and food prices, professional services that make up core inflation remain hot.

The Fed Funds Rate is currently 2.25%-2.50% with median bank transactions taking place at 2.33% as of last week. Based on the hawkish statements by various Fed officials in just the past few days, there is now a 59% probability for a 50-basis point hike and a 41% probability of a 75-basis point hike September 21.

Target Rate Probabilities Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Fed concluded QE in March, but that has a six-to-nine month lag effect before it is fully absorbed in the economy, and the same can be said about Quantitative tightening (QT) to the tune of $95 billion per month, which will be somewhat offset by Congress approving more stimulus to “help” the economy.

The big question is how well the market will manage this transition from easy to tight money. So far, it has responded better than most anyone expected. Fed policy far supercedes other factors that are thought to be serious market risks. And frankly, the market has shown, at least for now, little attenion to the Ukraine war, the energy crisis in Europe, a possible Lehman-style credit event in China’s property market, or the 20% crash in the value of the Japanese yen. While these and other external volatile situations may get a lot of airtime, no one on the floor of the New York Stock Exchange seems to care about such events.

Friday’s price action was very sloppy. Up until then, it hadn’t paid to fight the tape, but with the Fed on deck and the technicals presenting some fresh headwinds, the debate about whether July was a bear market rally or just a “pause that refreshes” will likely be answered by Labor Day. Stay tuned.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

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About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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