Here comes the bear market followed by a rally … what 2018 can tell us about what’s coming … more from Luke Lango on a “very rare” divergence that can make you huge returns

So, here’s what’s going to happen, according to our hypergrowth expert Luke Lango:

1. Stocks are likely to fall further in May; 2) the Fed is likely to turn dovish by summer; and 3) stocks will start rebounding before the dovish pivot.

Let’s dive into the details of this roadmap so you can expect what’s coming – and, more importantly, prepare yourself mentally and financially to take advantage.

***Today, the market is terrified that the Fed is about to destroy the economy

Let’s turn to Luke’s Daily Notes from his Innovation Investor service to better understand this fear.

If you’re new to the Digest, in Innovation Investor, Luke finds market-leading tech innovators that are pioneering explosive trends, capable of generating outsized investor wealth.

From his recent update:

The reality is that the Fed is shooting behind the duck with hiking interest rates. And investors are scared the central bank will send the U.S. economy into a recession by being too aggressive.

(Last Friday), for example, Wall Street research firm Nomura said that they expect the Fed to hike interest rates by 50 basis points in May, 75 points in June, and another 75 bps in July.

That would be a 200 basis-point tightening in just three months — and the most aggressive Fed rate-hike cycle since the 1970s.

That much hiking would significantly slow — if not kill — the U.S. economy.

If you’re scoffing at the idea of a 75-basis-point rate hike, I’ll remind you that it was just last Wednesday when Fed President James Bullard said he wouldn’t rule out a jumbo 75-basis-point rate hike.

And even if 75 basis points isn’t in the cards, the likelihood of a 50-basis-point hike, and potentially, more than one, has increased dramatically.

Last Friday, Fed President Jay Powell all but assured we get the first 50-basis-point hike next week when the Fed meets on Tuesday and Wednesday.

From CNBC:

“It is appropriate in my view to be moving a little more quickly” to raise interest rates, Powell said while part of an International Monetary Fund panel moderated by CNBC’s Sara Eisen.

“I also think there is something to be said for front-end loading any accommodation one thinks is appropriate. … I would say 50 basis points will be on the table for the May meeting.”

***The coming “pay attention to me!” tantrum from Wall Street

For a preview of what we can expect from Wall Street in response to this tightening frenzy, let’s look back at 2018.

In 2017 and 2018, the Fed pushed rates up to 2.375%, which was about 75 basis points further than Wall Street was expecting.

As Luke points out in his update, Wall Street was growing increasingly uncomfortable as the Fed was in the middle of this series of hikes. So, investors fired small warning shots throughout 2018 in the form of heightened market volatility.

Here’s Luke with how things played out:

The Fed didn’t listen.

Wall Street fired its big warning shot in December 2018 by pushing the S&P 500 into a bear market. That finally caught the Fed’s attention.

And by January 2019, the Fed pivoted dovish, and stocks were off to the races.

Right now, Wall Street is signaling to the Fed that it’s not ready for extreme, fast-paced rate hikes.

Here’s what today’s “warning shot” looks like. You’re seeing the Dow, S&P, and Nasdaq losing 5%, 9%, and 13%, respectively, over roughly the last four weeks.

Unfortunately, these warning shots are falling on deaf ears – so far. The Fed is in full hawk mode, more terrified of inflation than Wall Street.

Here’s how Luke sees this playing out, reminiscent of 2018:

So, Wall Street is going to step up its efforts to get the Fed’s attention.

How are they going to do that? 

By pushing stocks into a bear market.

***Preparing for another leg lower, then a blistering rally in the back half of 2022

Next week, we’re likely to see a 50-basis-point rate hike at the conclusion of the Fed’s May meeting.

We’ll probably also hear more tough talk on inflation and projections of a fast rate-tightening schedule.

In response to this, Luke sees Wall Street shooting its final warning shot – which means a bear market, or something awfully close to it – hitting in May or June.

But here’s the critical part: For long-term investors, this will be a buying opportunity.

Back to Luke:

This is an inherently dovish Fed. They’re acting hawkish now. But it’s all an act.

For years, this Federal Reserve has been the most dovish in history. As soon as the data gives it a reason to pivot dovish, it will do so (just like 2019).

And it seems the data will give it a reason to do that by June/July.

At that point, inflation will be falling. Economic expansion will be slowing, and stocks will be down.

That will be enough of a negative backdrop to get the Fed to ease up on its tightening cycle. Stocks will subsequently power higher.

Indeed, we think that dovish pivot will set the stage for a 25%-plus melt-up in the entire stock market into mid-2023. 

***How might you time the turn from bear to bull?

That’s where things get tricky. So, Luke’s blanket advice is simply to stay invested, especially in your top-shelf technology plays even if they’re underwater today.

But to give us a general sense of timing, Luke returns to 2018.

He references the chart we included earlier that shows the S&P alongside the Effective Fed Funds Rate. Here it is again for your convenience, followed by Luke’s commentary:

If you look at the chart above, stocks began rallying big before the Fed turned dovish.

That is, the central bank didn’t pivot until late January 2019, when — after hiking in every prior meeting — it left the benchmark interest rate unchanged.

But stocks bottomed out on Christmas Eve 2018, a full month before the Fed pivoted dovish.

During that month, the S&P 500 popped 14%. The Nasdaq rose 16%, and the ARK Innovation ETF surged nearly 20%.

In other words, the timing here is imprecise. All we know is 1) stocks are likely to fall further in May; 2) the Fed is likely to turn dovish by summer; and 3) stocks will start rebounding before the dovish pivot.

This imprecision is behind Luke’s suggestion to stay invested. Beyond that, Luke continues to identify high-quality opportunities that he believes will score big when the rebound comes – not to mention the next five-plus years.

***A “very rare” moment in stock market history

Last week, here in the Digest, we introduced an idea from Luke – the “divergence.”

In short, the prices of certain, elite technology companies are now becoming decoupled from the intrinsic value of those companies, as measured relative to their revenues/earnings.

Here’s Luke on the significance, from his latest podcast:

This has been a huge area of research for my team and myself over the past several months.

It centers around this very core and simple idea that the stock price of a company is ultimately determined by how successful that company is…

And how well a company is doing is determined by how much revenue it produces and how much profit it produces out of those revenues.

Luke makes the point that if you look at historical market data from the S&P back to 1990, you’ll see massive correlation between the S&P’s revenues/earnings and its market price. Specifically, it’s a correlation of 0.90.

Here’s Luke on the significance of this number:

For us to be seeing a correlation of 0.90 between revenues and earnings and stock prices in the real world, basically means that correlation is as strong as anything gets in the real world…

Stocks should follow the trajectory of earnings.

But Luke goes on to note that every once in a while, prices diverge from the revenue trend line. And this opens up a “divergence window,” as he calls it.

This creates the opportunity for a snap-back, wherein prices race higher toward their equilibrium level relative to revenues and earnings. When such a snap-back happens, Luke says you can see “enormous returns.”

Back to his podcast:

That’s the phenomenon we’re starting to see emerge right now, that’s only emerged about once a decade over the past 40 years.

And every time it has emerged it has created tremendous buying opportunities. And we think we’re seeing the same thing emerge today.

To listen to Luke’s entire thoughts in this free podcast, click here. And to join him in Innovation Investor to learn which tech leaders he’s loading up on, click here.

Bottom line, Luke is looking for more short-term pain followed by a massive rally in the second half of the year. Are you ready?

Have a good evening,

Jeff Remsburg