The S&P 500/SPX (SP500) is down by approximately 20% from its all-time high. The most highly observed global average dropped by 28% from peak to trough during the current bear market, but many excellent companies declined by 50-80%. Despite many significant selloffs, many stocks haven’t bottomed yet, and there is a high probability that the SPX will retest 3,500 or gravitate lower toward the 3,000 level.
The SPX – Solid Rebound Off 3,800 Support – Question is Where Next?
The SPX put up a formidable rally from its October low, appreciating by roughly 19%, falling just shy of a new bull market. Now, the $64,000 question is whether a new bull market began in October 2022, or was the recent rally just a bear market bounce, and could the stock market drop to new lows?
Intermediate-Term, or a Bear Market Bottom?
I discussed the 2022 mid-October bottom, why it was significant, and why the market would likely put up a big countertrend bear market rally into the 4,000-4,200 range. The SPX achieved its objective, “hitting another top” in early February, around 4,200, and it has been all downhill since then. The SPX trades below the critical 4K level and will likely go lower as we advance.
We did not hit an absolute bottom in mid-October, as no widespread panic selling or capitulation occurred. Also, the fundamental economic backdrop continues to deteriorate. The Fed remains hawkish as it battles persistently high inflation.
Moreover, I believe the economic image is worsening, and real pain for Main St. and Wall St. is still to come. I’m sure you’ve heard about the Silicon Valley Bank (SIVB) disaster. Well, prominent investors like Bill Ackman and others expect more banks to fail in the coming months.
Moreover, many top tech stocks became grossly overbought recently, reminiscent of the tech top I warned about in November 2021. Crucial consumer-related data could continue softening, and the labor market could be the final domino to fall.
Therefore, due to the weakening economy and a tight economic atmosphere, corporate profits could come down more than anticipated in many segments of the economy in future quarters. Furthermore, many market-moving stocks are far from cheap again after the recent run and need a specific catalyst to lift prices higher in the near term in my view.
The path of least resistance remains lower for now, and the SPX could retest the 3,500 level, achieving a double bottom or move lower towards my base case “bear market bottom” 3,100 – 2,900 zone.
The Technical Image – Continues to Deteriorate
The SPX had a textbook 19-20% countertrend bear market rally and recently put in a bearish head and shoulders pattern with the peak at approximately 4,200. The uptrend has been badly damaged as the SPX fell through its critical support level around 4,000, coinciding with the 50 and the 200-day MAs. We also witnessed negative signals from the RSI and other crucial technical indicators indicative of a near-term top. Now the SPX has a critical test around the 3,800 support level, and if this level buckles, we will probably see 3,500 or lower in the coming months.
What A “Real Bottom” Could Look Like
We didn’t witness significant panic and capitulation in the SPX, as the brunt of the selling fell on tech and other growth stocks. I expect more of a broad market selloff with capitulation and panic-like selling in most sectors when a long-term bottom occurs. Therefore, I think we will at least see a re-test of 3,500 SPX, possibly falling lower to approximately 3,000 after that.
The Fed – Staying Hawkish
The economy slows down as the Fed raises interest rates and implements QT. The cost of borrowing increases, and other negative consequences occur for businesses and consumers. Moreover, higher rates suck liquidity out of significant markets instead of increasing it as low rates and QE would. Therefore, capital and equity markets will likely feel more pain as the Fed’s tightening policy persists.
Inflation – A Persistent Problem
Some said that inflation was transitory and that the Fed had everything under control. However, CPI inflation peaked at 9.3% recently, around a 40-year high. Moreover, recent inflation readings have come in higher than expected, implying that the Fed will need to raise rates for longer and keep them elevated for longer than the market may like.
The Fed’s target rate for inflation remains at 2%, and recently the CPI came in at 6.4%, above estimates. Furthermore, critical inflation gauges like the PCE also came in higher than expected, inferring that inflation will probably remain challenging. While inflation persists, the Fed will likely keep interest rates elevated, leading to worsening economic conditions, a worsening labor market, and a potentially deep recession.
The Data – Continues to Worsen
On top of the hotter-than-expected inflation readings, the economy is confronted with worse-than-anticipated manufacturing, housing, GDP, ISM, and other critical data. Moreover, these worse-than-anticipated results are coming in after lowered estimates in most cases. Many segments, like manufacturing and others, illustrate that significant parts of the economy are in contraction.
Let’s Discuss The Recent Jobs Report
We received an exciting report as unemployment rose while nonfarm payrolls increased by 311K, beating analysts’ estimates by approximately 50%. Also, average hourly earnings increased by 4.6%, slightly less than expected. The takeaway is that it is likely only a matter of time before nonfarm payroll numbers worsen substantially. The lower-than-expected average hourly earnings increase also implies that the consumer may feel a big pinch as inflation continues to cruise far above wage growth. The labor market may be the last domino-standing, and if it drops, the stock market may experience a massive shock, leading to another significant leg lower.
The CPI Report
The CPI Report is out and about in line with estimates. Therefore, we see a relatively healthy response from many markets. Nevertheless, we see inflation persistently high, which provides the Fed with more ammunition to raise rates in the coming months and quarters. Therefore, while we see a constructive kneejerk reaction, the higher-than-anticipated CPI is likely a net negative intermediate and longer term.
The SVB Mess is Red Flag I Can’t Ignore
I heard of the Silicon Valley Bank for the first time several days ago. However, it looks like a problem that could lead to some contagion. The “sudden” failure of SVB is the biggest bank failure since the financial crisis of 2008, and unfortunately, we will probably see more bank failures as we advance.
SIVB: 18-Month Chart
SIVB’s stock has crashed from a high of about $750 to about $100, and investors like Bill Ackman and others say that other possibly more significant bank failures could be next. This dynamic creates uncertainty as the possibility of more bank failures, contagion, and other detrimental unintended consequences increases. Also, if you’re wondering why more banks could fail soon, we can thank the Fed and its ultra-tight monetary policy. If the Fed weren’t so gung-ho about QE unlimited, we would not be in this mess today in my opinion.
Warning Signs Reminiscent of November 2021
Have you seen stocks like Nvidia (NVDA), Tesla (TSLA), and others appreciating by 100% or more during the recent rebound? These are abnormal size gains and may only be sustainable for some companies. I wrote about the upcoming epic selloff around the November 2021 peak, and we’ve seen similar FOMO price action in Nvidia and other high beta stocks lately. This dynamic is concerning because we’re in a tightening economic environment, and valuations look quite rich again.
Stocks Far From Cheap
Shiller P/E Ratio
While the Shiller P/E (“CAPE”) ratio has decreased from the absurdly high 37 levels we witnessed at the height of the market in late 2021, it’s still quite elevated at 28. Provided the falling trajectory, the worsening technical image, the troubling fundamental backdrop, and other detrimental variables, we will probably continue seeing a slide in the Shiller P/E ratio. I don’t expect the CAPE to revert to the mean of 17. However, we could see the CAPE drop to about the 22-21 level, which is approximately 20-25% lower from here. Applying a similar decline to the SPX would bring the broad stock market average down to about 2,900-3,100, a level roughly consistent with my base case of a 3,200-2,800 ultimate bottom for the SPX.
The Bottom Line: Following My Game Plan
I reduced risk proactively around the 4,200-4,000 level top. Also, I incorporated a covered call plan into my investment strategy, utilizing collar and put options at times closing many put positions during the recent turbulence. Furthermore, I increased the AWP’s dry powder position to approximately 25% around the top, and I have deployed a substantial portion of that capital back into the market at lower levels.
Currently, my All Weather Portfolio is up by 12% QTD. We could continue seeing more of a stock picker’s market in the coming months and years. Thus, picking the right high-quality stocks, effective hedging, adjusting around peaks and troughs, and other variables can make an enormous difference between average returns and substantially beating the market. Technically, I’m watching 3,800 support here, which could lead to a retest of 3,500. Then, if the 3,500 support level does not hold, we could see another drop to around 3,000 in the SPX.