That didn’t take long.
The fall in the S&P 500 SPX index,
and Nasdaq Composite Index COMP,
After its meteoric rise from mid-June lows, many market commentators asked two key questions: Was this a fake bear market rally? Will the market retest the lows and go down?
My answers: No and no.
I argue that we are in the early stages of a new bull market, which means you should buy into any significant weakness like what we see now. I don’t want to despise skeptics. We need them. After all, a key component of any bull market is the “wall of worry”.
You always need large groups of people worrying about this and that, and predicting the downturn of the market and the economy, for a bull market to survive. Here’s why: since everyone is optimistic, there are no more people out there to to turn bullish and drive stocks higher.
Of course, I may be the one who turns out to be wrong. But here are my five reasons why we are in a new bull market phase and five stocks that are likely to outperform during this period.
Reason #1: High inflation is really transitory
Market bears tell us that inflation will remain high, forcing the Fed to raise rates so much that it causes a severe recession. They will get it wrong. But you can see how they would make that mistake.
First, a central flaw in forecasting is the habit of assuming that current conditions will persist. Second, it takes some time for drops in upstream inflation to reach consumer product prices and global inflation data such as the consumer price index (CPI). Before we get to the time it takes, consider all the really good news about upstream inflation that is simply being ignored because it hasn’t bled into global inflation yet.
* S&P Goldman Sachs commodity price indices for agricultural and energy commodities have recently dropped 18%-20% from their May and June peaks.
* Freight rates are down by a third from recent highs.
* The prices that companies pay clearly peaked earlier this year, according to the latest business surveys from the Federal Reserve District Banks of New York, Philadelphia and Richmond. They also showed lead times and backorder contracts sharply. This tells us that supply chain problems – a major source of inflation – are decreasing.
* New car production in July has recovered to late 2020 levels, which will put further pressure on already declining used car prices – down 3.6% in the first half of August.
I could go on. But the main point is that little of this has been showing up in headline inflation indices. So the bears remain unconvinced and pessimistic.
The next big inflation report will be the August CPI, to be released on September 13th. It will show limited impact from falling upstream inflation. A recent study by Goldman Sachs says that upstream costs take two to six quarters to influence key pricing measures. We’re not there yet. But we will get lower inflation numbers that calm the bears, convincing them to become more bullish and buy our stock.
Reason #2: Consumer confidence will recover
We all know that consumers drive most of our GDP growth – two-thirds or more. At the moment, consumer sentiment is very low – recently at a post-World War II low. This seems strange given that the job market is so strong. But consumers watch prices closely, and when they see prices rising too much, they turn negative.
Likewise, as inflation declines, consumer sentiment will increase. This will make consumer sentiment more positive, releasing animal spirits and spending.
Actions will respond. Despite all the attention to the Fed tightening, consumer confidence has a bigger impact on the stock market. There is a close correlation between rising confidence and stock market gains. This is the indicator to watch out for. Consumers also have room to borrow despite rising loan balances. Debt service costs and household leverage are still well below historical averages.
Reason #3: A recession is unlikely
I will avoid the highly politicized and silly debate about “what is a recession”, as the definition has been clear for years. The National Bureau of Economic Research (NBER) decides and considers many factors besides GDP, including the strength of employment.
The NBER is unlikely to determine that there was a recession for one simple reason: employment is very strong. Payroll employment increased every month for the first seven months of 2022 by 3.3 million jobs, to a record 152.5 million in July. We don’t usually have recessions when the job market is so strong. Retail sales rose 2.4% on a three-month annualized basis in July – another sign that there is no recession.
Of course, strong employment is a double-edged sword. When unemployment levels are so low – around 3.5% – recessions can occur. The job market is so tight that companies can’t find more workers to keep growing. This time, however, the labor participation rate remains repressed. More people going back to work would buy us time on this expansion.
Even if that doesn’t happen, we see an absence of the excesses that normally contribute to bad recessions – like the tech bubble of the late 1990s or the housing loan bubble of 2005-2007. So even if we have a recession, it could be mild. As for the two consecutive GDP declines that politicians are talking about – the jury is still out on that. This data can be revised upwards significantly. It’s already happening.
Reason #4: Covid is on the run
Covid has been cunning, so no one knows if it’s really kicking back. But so far, at least, no new Covid variant is behind the scenes to replace BA.5. So many people have built up natural immunity because they have caught Covid, any new variant may have a hard time gaining traction.
We will learn more when the cold weather arrives in October and November. But if that good fortune holds, it will be bullish for the economy. This means more people will travel, driving up spending in the accommodation and restaurant sector.
More importantly for the global economy, a remission means China will more decisively end lockdowns, creating a re-opening recovery in the second half of the year. This would support global growth. Yes, the July data showed that China’s economy was weak. But the People’s Bank of China recently cut key rates unexpectedly, for a token amount. The reversal tells us it is open to more rate cuts. Meanwhile, China’s Premier Li Keqiang recently urged provinces to increase fiscal spending.
Reason #5: The feeling has hit a bottom
Investor sentiment hit extreme lows in mid-June – the kind of lows that happen around pivotal market bottoms. Sentiment is hard to track – in part because you also need to monitor yourself. But one indicator I use as a handy shortcut is the Investors Intelligence Bull/Bear Ratio.
It fell to 0.6 near June market lows. This is a capitulation, suggesting that investors have thrown in the towel and given up – the way they often do in market bottoms. The June reading was the lowest since March 2009, the market low in the last bear market. The bear rate hit 0.56 the week of March 10, 2009, and the stock market bottomed that week, March 11.
The good news here is that the bull/bear ratio remains bearish at 1.52. Anything below 2 tells me the market is very buyable from the way I use this meter.
the bottom line
Considering all the lingering fears about inflation, the Fed and the recession, it’s no surprise that investors remain so pessimistic. Instead of joining the bear crowd as stocks fall, think of it as the classic buyable “wall of worry” that all bull markets need to climb.
In that environment, it makes sense to buy stocks – starting with names that have protective moats but seem cheap because they have a rating of four or five stars (out of five) on Morningstar Direct.
The defeated FAANGs of Alphabet GOOGL,
and Meta META,
everyone fits, just like JP Morgan JPM,
and Nike NKE,
To learn more about this stock selection approach, see this column of mine.
In the short term, we may see weakness in September. It is historically the worst month for stocks. It is also the month when the Fed intensifies its quantitative tightening. So, as always, it’s best to plan your stock purchases in phases.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned GOOGL, AMZN, META, and NKE. Brush suggested GOOGL, AMZN, META, JPM, and NKE in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.