Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Q
More Bad News That is Good

Aug 2, 2022

Yesterday the July S&P Global US Manufacturing Purchasers Management report was revised to 52.2 from 52.3, indicating that factory orders have continued declining since early summer and are now at the slowest pace since June 2020.
Econoday had this commentary on the report:
 
“New orders last month contracted for the second straight month and at the steepest pace in two years and, outside of the pandemic, the steepest pace since 2009. Output was also negative, edging into contraction for the first time since early on in the pandemic. Pressures in both costs and selling prices eased though still remained historically high. Respondents say customer spending, both domestic and foreign, are being affected by further supply chain disruptions and by high prices.”
 
The Bureau of Economic Development announced that the second quarter was the second consecutive annual rate of decline in the US Gross Domestic Product (GDP), representing the overall economic activity of the US. Here is what they reported:
 
  • Q1 2022 | -1.6%
  • Q2 2022 | -0.9%
 
The second quarter decline was less than the first quarter due to an upturn in exports and a smaller decrease in federal government spending. Two consecutive quarterly declines in the GDP confirm the US is officially in a recession at the end of June 30.  
 
However, all this bad news is music to the ears of the Federal Reserve committee that has been laser-focused on slowing the economy and reducing inflation. As we have been reporting in previous Weekly Briefs and specifically in our June 22, 2022 Brief titled, “Jerome Powell the Giant Slayer” there is continuing evidence the Federal Reserve rate hike policy has both provided reserves for the Federal Reserve and slowed price increases and the overall economy.  
 
The challenge now and fears reported extensively by the main media all year is the risk Federal Reserve will be too aggressive with rate increases and damage the stability of the economy.  
 
This has been the storyline of the main media and their interpretation of why institutional investors began reducing stock allocations at the start of the year. Apparently, either the main media or institutional investors (or both) place a low probability that the Federal Reserve can delicately slow inflation while not jeopardizing the overall growth of the economy.  
 
Analysts are projecting another Federal Reserve rate hike by as much as 0.75% at the Federal Reserve’s next meeting. Based on the S&P 500 steady rise from its June 17 low, investors may have already priced in the impact of another rate hike. The question is whether the Federal Reserve will pause or end its rate hike policy at subsequent meetings, being satisfied that the economy and price increases are approaching their target annual growth rate. 
 
It is interesting to note the continued doom and gloom projections of perennial market bears are predictably saying the rally from June 17 is not due to the worst being over but the eye of the hurricane. In their opinion, the worse is yet to come with a steeper selloff for the second half of the year.  
 
This is a scary prognosis but seemingly improbable. The US $16 trillion economy doesn’t slide into long-term recessions over just a few months of declines and especially as the Federal Reserve is raising rates. Typically, if the Federal Reserve is concerned about the economy, it decreases rates. Secondly, recessions don’t develop while corporate America is still growing.  
 
Yahoo! Finance provided the following information on second-quarter earnings reports released on July 26,
 
“Including all the reports that came out before the market's open on July 26th, we now have Q2 results from 134 S&P 500 members or 26.8% of the index's total membership. Total earnings for these companies are down -5.8% from the same period last year on +7.9% higher revenues, with 73.9% beating EPS estimates and 64.2% beating revenue estimates.”
 
Notice that while earnings have predictably declined in Q2 by -5.8% and the focus of the main media, revenues are higher by 7.9%, and 73.9% of the reporting companies beat earnings per share estimates and 64.2% beat revenue estimates. The earning reporting season is still early, and I will keep you posted as more companies release their reports.
 
When the US economy is in trouble, headlines include the words “declining,” “slowing,” “disappointing,” and other negative adjectives. However, during the first half of 2022, as stocks were selling off, companies continued to report stable or rising sales and profits. As stocks were declining due to fears of a recession, the US companies were increasing their payrolls and still have over 10 million job openings. Adding new employees is an expensive and long-term commitment. Companies don’t increase their employee personnel if they don’t forecast continued growth.
 
Today the US Labor Department released its Job Openings and Turnover report (JOLT), indicating that job openings declined by 605,000 with a net 10,698,000 job openings still available with an unemployment rate of 3.5%. If the US economy is spiraling into a recession, then why are companies posting over 10M job openings and triple the number of typical monthly job openings going back twenty years?
Key mistakes investors can make depending on major media analysis and relying on government reports that are indications of the past and may not be the future. Also, the media seems to be running out of content as they continue to restate the same storyline since January of fears of inflation, interest rates, Ukraine, recession, etc.
 
The S&P 500 index that represents 503 of the largest US companies has steadily risen since June 17, the date we cited as potentially the market low for the next 12 -18 months. The fact that the index has steadily risen over the past six weeks is the result of institutional investors buying more than they are selling which is an indication they are adding to their stock portfolios.  
 
As my father would say, “figures don’t lie, but liars can figure.” Opinions are one thing, but the fact is the S&P 500 index has rallied since June 17 and, more importantly, cleared several positive technical levels.

First, you will notice from the chart above that since June 17 that each selloff stopped above its previous low, and each new rally of the index rose above the previous high point. Looking at the chart below and of the previous 2020 selloff, you will notice that the turnaround and huge buying opportunity occurred on March 26 when the S&P 500 index rallied above its 20-Day Moving Average (DMA), then surpassed its 50 DMA, then its 200 DMA, and onto new all-time highs. 

What Does This Mean to Me?

Buying low and selling high is exactly that. But when the market and bad news is everywhere. Sell when everyone is making profits and seemingly no end in sight of good news. The best buying scenario we look for is buying when the apparent low has been reached of the selloff and waiting for confirmations that a new rally has been initiated. The tricky part is not being too early to claim the bottom and then get stung as the market resumes its selloff. The June 17 low makes sense that the worse is over, considering that corporate America continues to report growing earnings and sales. Also, the selloff was meaningful, reaching bear market status by declining 20% or more, with the S&P 500 dropping 23.07% and NASDAQ 31.95% at the close of June 16. Capping off the end of the selloff is the official recession status of the economy. 
 
The Federal Reserve has accomplished a need economic slowdown, and if they indicate a slowing of their rate hike policy at their next meeting, we believe the economy and stock market are set for a multi-year rally into the next presidential election. Conversely, should the Federal Reserve continue to increase its discount rate through this year, then investor concerns of a deeper recession may be valid. At this point, it appears that institutional investors are comfortable with the Federal Reserve policy and, since June 17, have been quietly adding to their portfolios.
 
We maintain our favorable view of the US economy and stock market. The key to building wealth is entirely dependent on having defined goals and executing your strategy.  Give us a call to discuss your financial and investment planning. We have decades of experience working with clients and look forward to assisting you.

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