No major corrections coming, but also no breakaway bullishness … the crosswinds impacting the S&P … what our Strategic Trader analysts are watching for … their market forecast
Our technical experts John Jagerson and Wade Hansen say we can rule out a big move to the downside.But if you’re expecting a strong, sustained bullish surge, don’t hold your breath.So, where does that leave us?Waiting on more definitive data.According to John and Wade, investors are stuck between two conflicting crosswinds today…Relatively strong market fundamentals that are robust enough to prevent a major drop, yet growth expectations that are too weak to support a rip-roaring bull.Let’s look at this in more detail.
Why investors don’t have to fear a major selloff
Before we jump into our analysis, for our newer Digest readers, John and Wade helm our trading newsletter, Strategic Trader.This premier trading service combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.John and Wade’s arsenal of trading indicators provide helpful insights about the market’s likely coming direction.That brings us back to where investors find themselves today.Let’s begin with the good news. Despite a mixed earnings-season so far, John and Wade do not believe we’re at risk of a major market selloff. Why not?Our technical analysts point toward the respectable shape of profit margins.From their latest Strategic Trader update:
…As inflation has climbed, costs have risen (and continue to rise), and profit margins have come down.According to FactSet, profit margins across the S&P 500 should come in around 11.4% this quarter, which continues a decline from the highs 13% in 2021.On the surface, this seems bad, but profit margins between 8-11% are the long-term norm in the S&P 500, not the exception…There is no reason to assume stocks can’t be in a bull market again if profit margins fall back to the long-term average.
If you read yesterday’s Digest, this sounds familiar. Yesterday, we pointed out how analysts’ expectations for 2023’s profit margins are actually headed higher.And we asked how this could be since it appears we’re headed into a period of economic weakness.To be clear, we remain concerned that rosier-than-justified profit margin estimates could result in a market selloff if those expectations aren’t met later this year. But John and Wade are correct in that a return to “average” profit margins is enough to support longer-term market gains (though possibly after Wall Street throws a brief tantrum at smaller-than-expected profit margins).Either way, that’s a dynamic that won’t play out until later in 2023.
So, what’s the bearish influence that will prevent stocks from breaking out into wild bullishness?
Growth expectations.Back to John and Wade:
The big X-factor this quarter that could keep the market bound inside its recent range is the outlook for growth.Regardless of the current numbers, if the outlook from management is negative, we could see some short-term profit-taking.So, while we don’t think the market fundamentals justify a negative view, we still think being cautious is wise.
John and Wade point toward Wall Street’s reaction to Microsoft’s earnings report from earlier this week as a perfect example of this bull/bear tension at work.While beating earnings forecasts, Microsoft boasted 38% growth in its cloud computing platform (Azure). The strong performance sent Microsoft shares up 5% in post-market trading on Tuesday.But then came the discussion of future growth.Here’s John and Wade with those details:
However, just after the report, MSFT’s CFO told investors that management believes the growth rate will slow by 4-5 percentage points.You can see the whipsaw that occurred in the post-market (blue-shaded area) on the following five-minute chart of MSFT.
The bottom line at this point is that market fundamentals are strong and should keep the market above its lows, but the trend in growth rates needs to improve to justify a strongly bullish outlook.
The “sign of confirmation” that John and Wade are waiting to see
In Monday’s Digest, we presented a chart of the S&P, showing it running into its multi-month down-sloping trendline. The question was whether the bulls would have enough strength to finally break this critical resistance level.Here’s that chart from Monday.
Well, it happened.This week, the S&P finally pushed north through this key resistance point.This is big. It’s a significant show of strength that suggests the market could be on the verge of a major directional shift.Here’s how this looks…
But while John and Wade are encouraged by this resistance break, it’s not yet enough for them to go full-bull.Here they are with what else they want to see:
…We are still waiting for confirmation from the other major indexes before getting too excited.Confirmation from the other major indexes – especially from small-cap stocks would consist of breakouts above their prior highs.For example, although the S&P 500 has crossed a critical technical level, the small-cap Russell 2000 Index is bumping against strong resistance at 1,900.
While an investor could gamble on the S&P’s resistance-break alone, John and Wade tell us that waiting for confirmation of a breakout is a classic technique to reduce the possibility of buying a false breakout or “whipsaw.”Back to the Strategic Trader update for when we might see the Russell break bullish:
As long as the Fed doesn’t act too aggressively next week, we think a solid confirmation signal from the Russell 2000 could appear when the labor report is released on Feb. 3.
John and Wade wrote their update on Wednesday. As I write Friday at lunch, the Russell trades at 1,905. We’ll be watching to see if this level holds and can support a new bullish climb.
Put it all together, and how are John and Wade sizing up upcoming market conditions?
Overall, when compared to long-term trends, our technical experts are pleased with earnings season results so far.While the outlook has been mixed – which they do find “concerning” – they’re not seeing any significant threats to market support.Here’s their forecast as they look ahead:
The new breakout on the S&P 500 is encouraging, but we recommend waiting for confirmation before shifting your bias in a more bullish direction.For now, we plan to continue to focus on generating income from our long positions at the highs and sell puts on quality stocks when they hit lows.While the outlook for 2023 is still a little neutral, we are optimistic that there will be many more opportunities for short-term profits as we get further into the first quarter.
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