A huge battle playing out between the bulls and bears … so much rests on Q2 earnings … get ready for a month of important data releases

The markets are setting up for a dramatic breakout – the question is: “In which direction?”

Either the bears are overly pessimistic, and the next few months will reveal reasons for optimism. Investors will step back into the market as they realize “wait, prices have sold off too much! Things aren’t that bad after all!” …

Or…

The bulls will realize that their rose-tinted glasses were just masking reality. Earnings that miss the mark will result in another sharp leg lower from stocks as investors reprice assets based on a recessionary environment.

Right now, there’s not enough information to push us decisively in either direction. But the next month will bring updated data sets that part the clouds.

A breakout is coming.

***Beginning with an optimistic view of the markets, legendary investor Louis Navellier points toward historic bear-market data and subsequent rallies

For newer Digest readers, Louis is a legendary quantitative investor. “Quant” simply means he uses numbers and algorithmic rules to guide his investment decisions. Forbes even named him the “King of Quants.”

As you might expect, a numbers-based analysis of how markets have performed in the past plays a significant role in Louis’ expectations about how markets will behave in the future.

So, what are the historical data suggesting about today’s market?

From Louis’ Accelerated Profits update yesterday:

Our friends at Bespoke also recently pointed out that the S&P 500 tends to rally strongly after it declines 15% or more in a quarter. The S&P 500 fell about 17% in the second quarter.

In the previous eight instances when the S&P 500 slipped 15%, the index has bounced seven out of eight times in the following quarter and eight out of eight times in the following six months and 12 months.

Breaking it down further, the S&P 500 has posted an average 6.22% gain the following quarter, a 15.15% gain in the following six months and a 26.07% gain in the following 12 months.

So, if you’ve been looking for good news after the dismal first six months of 2022, this is it!

To be clear, Louis isn’t calling for markets to head straight up from here.

He believes we’re still in for significant volatility, especially if the numbers show that we’re already in a recession.

On that note, I should point out that the numbers are deteriorating quickly.

The Federal Reserve Bank of Atlanta’s GDPNow Index, which aims to track the economy in real time, is showing the latest estimate for Q2 GDP as -2.1%.

Keep in mind, just last week, the index was calling for a -1% contraction, and only days before that, the figure was just -0.3%.

Back to Louis for where he’s focusing:

While we wait for more economic data to support the recent claims that the U.S. is in a recession, I’m pleased to report that we are not in an earnings recession.

In fact, the analyst community remains relatively positive about the upcoming second-quarter earnings season – and for earnings expectations in full-year 2022.

***These “relatively positive” earnings expectations are behind much of the confusion about whether the bulls or bears will win the breakout battle

Back to Louis with the specifics of these positive estimates:

According to FactSet, the S&P 500 is expected to achieve 4.1% average earnings growth and 10.1% average sales growth in the second quarter.

Looking further out, FactSet estimates earnings growth of 10.5% in the third quarter and 9.7% earnings growth in the fourth quarter.

So, when you add it all up, analysts anticipate calendar-year earnings growth of 10.2%.

In other words, there’s no “earnings recession” in sight – and a flight to quality should light a fire under many fundamentally superior stocks…

Now, bears will look at these estimates and say: “I’m not buying it. It’s one thing to say that earnings will remain steady in today’s economy. But how are earnings going to climb in the face of an economic slowdown that’s resulting in negative GDP estimates?”

Let’s make one distinction – it won’t be surprising to see certain sectors post healthy earnings numbers.

For example, Louis has been loading up his portfolios with energy, shipping, and some top-tier semiconductor stocks. Those should report strong numbers.

But strong earnings growth for the entire S&P 500?

***For a different perspective in this headscratcher, FactSet reports that the current earnings per share estimate for the S&P for 2022 comes in at $229.63

At today’s price-to-earnings multiple of 19, this estimate suggests the S&P will finish the year at 4,363.

That’s 14% higher than where the S&P trades as I write Wednesday morning.

So, if earnings do come in along the pace of these current forecasts, the markets are priced too low. We’re in for a strong rebound to end the year.

But what if these estimates are way too high?

What if they’re not adequately reflecting the current -2.1% contraction estimate in the GDP, or any number of red flags suggesting a weakening economy? For example:

• Personal spending fell in May for the first time this year.
• A U.S. manufacturing gauge hit a two-year low in June.
• There’s been a sharp uptick in consumer debt spending, with a drop in consumer savings.
• And let’s not forget yesterday’s fresh yield curve inversion between the 10-year Treasury and two-year Treasury, which remains inverted as I write.

We could go on… But for one example in greater detail, take the commodities market:

Copper is used in just about everything – from buildings, to batteries, to handheld electronic devices; you name it.

Given this all-purpose functionality, if you want to get a sense for where the economy is going, look at copper’s price, which reflects its demand.

Right now, it’s tanking.

Since early April, while the S&P has bled off a painful 16%, copper futures have imploded, falling 29%.

So, let’s say the bullish earnings estates are too high – call it 15% too high. And let’s say these missed earnings weigh on investor sentiment, dragging the price-to-earnings multiple down to its long-term average of 16 (compared to 19 today).

That means the S&P would finish the year at 3,123, which is about 18% lower from here.

So, in scenario #1 with good earnings and steady investor sentiment, we soar nearly 14%.

In scenario #2 with missed earnings and gloomy investor sentiment, we drop another 18%.

If you’re weren’t entirely sure about my use of “breakout” at the top of this Digest, this should explain it.

***As we noted in the Digest last week, July will remove many of the clouds obstructing our view of where things are headed

Everything comes back to the interplay between inflation, Fed policy, and economic earnings.

If inflation comes in much cooler than expected and gives the Fed confidence that we’re regaining control, it increases the odds that the Fed slows down rate hikes.

Pressing pause on rate hikes supports the economy, keeps borrowing costs for consumers and businesses under control, and increases the odds that we either skirt a recession or have only a mild one.

If inflation stays high or appears to be more entrenched, the Fed is likely to continue with its accelerated rate-hike plans. That would toss a wet blanket on the economy, likely resulting in a recession, depressed earnings, and another dump in the stock market.

This month will bring new data on all of these influential variables:

First, we get the next CPI print on July 13.

Though the Fed prefers to watch the Personal Consumption Expenditures Price Index (which comes out on July 29), you can be sure they’ll be watching the CPI print, too.

Second, Q2 earnings season kicks off in earnest the following day on July 14, with JPMorgan reporting.

This will be huge, providing us the much-needed insights about earnings estimates versus reality.

Third, the Fed’s next policy meeting concludes on July 27.

We’re going to know whether or not the Fed will carry through with its anticipated 75-basis-point hike. And as importantly, we’ll get commentary from Federal Reserve Chairman Jay Powell.

Fourth, the next day we’ll get the advanced estimate for Q2 GDP, potentially showing we’re already in a recession.

Clearly, lots of fireworks coming in the next month that could be a needle-changer for your portfolio.

We’ll keep you updated.

Have a good evening,

Jeff Remsburg