(Please enjoy this updated version of my weekly commentary published July 22nd, 2022 from the POWR Stocks Under $10 newsletter).
Over the last week, the S&P 500 (SPY) is up by 5.5% with even bigger advances for the Nasdaq and the Russell 2000. Gains were pretty strong across the board as well.
This is another change in character for the market as previous advances in 2022 have featured weak participation.
Some reasons for the market rallying are Q2 earnings that are pretty resilient, while inflation continues to move lower. And, this comes about in an environment that featured record levels of bearish sentiment by many measures.
Bear Market Rally Thoughts
[I shared these thoughts about a bear market rally in my Monday commentary for POWR Growth subscribers. This is an excerpt with some modifications for stocks under $10. ]
Today, I want to put on my bull hat and argue the other side. First, I don’t think another bull market, beginning from here, is possible.
Instead, I do think a bear market rally could happen and is something that we should consider a possibility. Although, it does require a series of positive catalysts.
First of all, sentiment is extremely bearish. This means that any positive news could spark a big rally. As noted, inflation falling is a bullish force that has been providing support to long-duration assets. China is easing. Earnings haven’t been as bad as expected.
If we look back at previous bear market episodes, we find powerful bear market rallies between 15 and 25% that lead to sentiment becoming bullish or at least neutral. We haven’t had one yet, which means that we are due.
Now, let’s throw some harsh reality on that pretty picture…
A lot of ifs are necessary for a big bear market rally to come to fruition. And, each of the bullish catalysts could fizzle as they have for much of this year. Let’s go through it:
Bearish sentiment in a bear market is a useless indicator. Inflation has failed to decline despite many forecasts of it declining. Anyways, it’s not falling because we added new capacity to the economy, it’s going down due to an impending recession.
Chinese stimulus hasn’t flowed into the economy because of Zero-COVID policies. And, earnings season is only beginning, and analysts continue to forecast positive EPS growth in Q3 and Q4.
Targets + Applications for Our Portfolio
In terms of how far we could go, I believe a reasonable target would be around 4,200 on the S&P 500 (SPY) which is about the midpoint of the decline.
More important is what I’m looking for qualitatively. I’m looking for sentiment to get very bullish, especially on a short-term basis. I’m looking for more and more people to declare that a bottom was in.
This would be a perfect time to get to a more neutral allocation given the backdrop and likelihood of a deeper, earnings contraction.
Final Thoughts
To sum up my thinking: We are in a bear market. The economy is slowing which means more pain is coming. However, I believe that the ‘window is open’ for a bear market rally.
In terms of the portfolio, we have marginally increased exposure but are ready to get back to a more neutral position if we break below the mid-June lows.
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SPY shares fell $398.79 (-100.00%) in premarket trading Friday. Year-to-date, SPY has declined -15.41%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.
How Long Can This Bear Market Rally Last? StockNews.com
