Because as brutal as the market has been in 2022 so far… it’s likely to get a lot worse. Why? As the Q2 earnings season is about to kick off and early indications are pointing to a worsening earnings, which is likely to make the stock market (SPY) rally. This is not a problem for those who trade this bear market well. If you’re not sure what to do, read on for this essential commentary with a timely market outlook and bear market trading plan.
(Enjoy this updated version of my weekly commentary from the Reitmeister Total Return newsletter).
In recent commentary we discussed why it is a bear market. And how much lower stocks should go. Even the reasons behind the circuitous path that stocks must take to find the ultimate bottom.
This last part is interesting as we work our way into the second quarter earnings season. During bullish times, these reports often act as the catalyst for the next leg higher.
Unfortunately, this time it could do the exact opposite, as Wall Street is too late to acknowledge the recession. So if a higher-than-normal percentage of companies show weak results and a lower forecast for the future, that will give investors enough reason to hit the sell button again, pushing stocks to new lows.
Let’s talk about that and our trading plan in this week’s market commentary…
Earnings season is always important. But this time it takes on special meaning as investors fear recent economic weakness will show up in these reports. If that’s true, then get ready for the next leg of lower as the reports come out in July.
As noted last week, the average recession is bringing a 26% drop in earnings per share for S&P 500 (SPY) companies. This is a big part of why stock prices fall. Some of that is already reflected in the current sale pending this move… but certainly not all of it.
Let me repeat some of the math from last week so you can understand why valuations will be too high once the revisions happen and why this points to further downside.
“Let’s break that part down because it’s not intuitive on the surface. Right now, Wall Street analysts are still forecasting $231 in earnings per share for the S&P 500 (SPY). At the current price level of 3,821, that amounts to a PE of 16.4.
Yes, that’s more reasonable than the 21.4 peak PE for stocks in January. But it is still above the historical average of 15.5. And typically stocks go well below their historical average in the latter stages of the bear market cycle before the next bull shows up. So even without an imminent cut in earnings estimates, stocks are still a tad too high to call the low.
Now let’s say Wall Street analysts finally get the memo that this is indeed a recession on the way and start the process of lowering future earnings estimates. Well, the average recession is accompanied by a 26% cut in the earnings outlook. I suspect this one will be on the milder side. So let’s go with 20% off.
That would lower estimates from the current one to $231 to just $185. Given today’s closing price, the PE would move back up to 20.7.
Your eyes do not deceive you. Valuations will in fact have moved back to near the starting line, like when we were at the highest level and forced investors to lower prices to get PE more in line.”
This brings us back to the idea of how low should stocks go to squeeze out excess valuation to pull investors back for the next bull run?
Earlier, I predicted that the bottom for this bear market will be slightly more than the 34% average decline. Maybe 40%. Not because I expect a worse than normal recession. Rather, it is because valuations have moved higher than normal in the low interest rate environment and that surplus needs to be drained.
Another way to put it is to say that everyone got drunk on stocks during the last bull market party. And now we’re dealing with the morning after hangover.
3,180 = 34% decline from the previous peak of 4,818
3,000 = 37.7% decline and interesting resistance for stocks to battle over.
2,891 = 40% drop
Now let’s take a look at these past stock price predictions versus the earnings valuation downturn story.
I’m guessing stocks will need to hit around 15-16x the lower earnings estimates of $185. That creates a fair value of 2,775 to 2,960. That prediction pretty much lines up with what I’ve shared above.
Now we have 2 different ways of looking at where the bear market should be low and they align pretty well. But here’s the sad part. No matter how much we want the market to trade in logical order… IT WON’T!
This means that just because we’ve made logical predictions about where stocks might go… there’s nothing written in stone that it will turn out this way. So it requires a more flexible strategy of when to take profits and when to start buying for the next bull run.
I feel we should start making some profit on our short positions around the 34% decline level (3,180). Especially the short positions with the highest beta. Maybe even a touch for it.
Since I feel there will be a long battle of over 3,000, and it could indeed be the bottom, start returning to a hedged portfolio by balancing our short positions by bottom fishing some stocks that are in the early stages of the next should rise bull market. Such as cyclical stocks (energy, chemicals, materials etc).
Yes, we are a little ahead of ourselves, but it’s good to have a plan to figure out why the stock is likely to fall. And so when we need to take our short stock gains off the board and switch to offensive mode for the bull market re-emergence.
For now, with a closing price of 3,831 today… a lot more downside is likely to be expected. And yes, broad weakness in earnings reports this quarter would certainly be a logical catalyst to get us down to test those lower levels.
Our portfolio of 4 diverse inverse ETF positions is well positioned to take advantage of this environment. The same goes for our 2 trades with higher rates, both of which made their way into the plus column today as well.
Since the beginning of June, this plan has worked wonders for us, as we made some nice gains while the S&P 500 fell a whopping -7.28%. So you can imagine how much more impressive it will be if we do indeed have another 10-20% more disadvantage until we find the bottom of the bear market.
What to do?
Right now, there are 6 positions in my hand-picked portfolio that will not only protect you from an impending bear market, but also lead to big gains as the stocks fall.
Such as the ample gains enjoyed by our members in June when the market finally tumbled into bear market territory.
This unique strategy fits perfectly with the mission of my Reitmeister Total Return service. That is to provide positive returns… even in the face of a roaring bear market.
Come and discover what my 40 years of investment experience can mean for you.
Plus, access my full portfolio of 6 timely trades to not only survive…but thrive in this unforgiving bear market environment.
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I wish 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 fell $0.25 (-0.07%) in after-hours trading Tuesday. Year-to-date, the SPY is down -18.98%, versus a % increase in the benchmark S&P 500 index over the same period.
About the author: Steve Reitmeister
Steve is better known to the StockNews public as “Reity”. Not only is he the CEO of the company, 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 selection.
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