The Worst of the Selloff Is Over; Here’s How to Spot Winners

The stock market is off to a wacky and wild start in 2022. And amid all the huge rallies and selloffs in the market today, you’re naturally asking yourself: What’s next?

Yesterday was a remarkable day in stocks. It was, in all honesty, one of the wildest trading days I have ever witnessed — but it could mark the bottom of the recent market crash.

Long story short, markets plunged Monday in early trading. And by plunged, I really mean plunged. All three major indices — the Dow Jones, the S&P 500 and the Nasdaq — dropped more than 3%.

At one point, the Nasdaq was down nearly 5% in early trading. Drops that big in a single day have only happened during two other times over the past 15 years: 2020 and 2008.

It was capitulation.

The word "rebound" flashes on a stock market ticker board.
Source: Shutterstock

Then, like a rubber band, we snapped back. And, boy, was it fast and furious. By the end of the day, all three major indices had turned green, including the Nasdaq! The tech-heavy index rallied an absurd 5.8% off its morning lows. Some years, stocks will go a full 12 months and not rise more than 5.8%. We just witnessed a rally that big in a matter of hours!

Reversals like this rarely happen in markets — but when they do, they’re pretty bullish.

It looks like a lot of smart money was sitting on the sidelines during the recent selloff, waiting for a capitulation moment on the idea that stocks are actually in a healthy position. They just needed a valuation reset.

We got this reset over the past few weeks, as we’ve been talking about. Today, we got capitulation. Smart money piled in. Everyone else followed suit.

Post-Selloff Outcomes in the Market

The implication of Monday’s price action, of course, is that the worst of the recent market selloff is over — and that stocks will start powering higher again.

Do we agree with this thesis? Partially.

This will play out one of two ways:

  • Earnings season over the next few weeks proves to be very impressive. The U.S. Federal Reserve issues a semi-dovish statement on Wednesday, and stocks move higher, with today being the bottom.
  • Earnings season disappoints. The Fed stays hawkish on Wednesday, and the market selloff resumes.

After Monday’s capitulation moment and bullish market reversal, the former outcome is more likely than the latter. However, we also believe the latter could still materialize. We apply a 65% likelihood to scenario one and a 35% likelihood to scenario two.

We are long-term focused, of course. But if you are also a short-term trader, we believe the best way to trade this market is as follows:

  • Buy into the rally, with a focus on beaten-up tech stocks that showed signs of life in today’s reversal.
  • Set stop losses on your new investments at 10%. Traditionally, we are opposed to stop losses. But if trying to trade amid this market volatility — and with the potential for a big downturn on the horizon — they will help mitigate your losses.
  • Wait for earnings today and Wednesday — and for the Fed’s statement and Chairman Powell’s press conference on Wednesday.
  • Observe the market action into Thursday. If stocks rally hard on earnings and a dovish Fed, stick with the rally — and get ready for a great 2022 rebound.
  • If stocks fall hard because earnings disappoint and the Fed stays hawkish, let the stop losses protect you and move to the sidelines until the Fed hikes rates. This will probably happen in March. Reassess conditions at that time.

What Winners Look Like in the Stock Market Today

In every rough patch for the stock market, there are unique winners that don’t just outperform the market — they actually make you money while everyone else is losing it.

So I’m here today to tell you about those stocks.

Specifically, amid this market volatility, stocks with three very identifiable features will work. Those features are:

Profits: This is the show-me-the-money year. When the market’s flooded with liquidity, investors are fine betting on stories, hopes and dreams. When that liquidity leaves — as it will in 2022 — investors are only willing to bet on stocks that are executing on those stories, hopes and dreams. That’s why stocks with real operations and profits today will likely outperform in the near term.

Relatively low valuations: Year to date, high valuation stocks have been crushed because they are the most sensitive to rising Treasury yields. Stocks within the highest decile of price-to-sales multiples are down big on the year, while stocks in the lowest decile of price-to-sales multiples are up. This pattern will likely persist in the face of Fed policy uncertainty.

Cash-heavy balance sheets: When interest rates go up, financing costs go up. And so companies with a lot of debt on their balance sheets see their net profit margins get squeezed and their earnings get chopped. Cash-heavy, debt-free companies don’t face those headwinds. Those stocks will work in 2022.

Basically, over the next few months, it’ll be the money-making, reasonably valued, cash-rich stocks that win on Wall Street.

To be clear, this trading action won’t last forever. We see parallels to 2016. Back then, everyone was freaking out at the prospect of the Fed hiking rates. But when they actually hiked in December 2016 and proceeded to hike another eight times into late 2018, the market went back to normal. And stocks with the best earnings and sales growth were the biggest winners.

Money-Making, Reasonably Valued, Cash-Rich

Make no mistake: The best way to make money in the markets over the long run remains to invest in the world’s most innovative companies making the most valuable products and services. They’ll benefit from tremendous sales and earnings growth in the long term, and all that growth will power those stocks higher.

But occasionally, the stock market undergoes volatile trading periods where the “winners” and “losers” are determined not by earnings growth but by other factors.

So what’s the best trading strategy here?

Stick with hypergrowth tech stocks. But put an extra emphasis in the near-term on buying money-making, reasonably valued, cash-rich hypergrowth tech stocks.

That’s what we’re doing in our flagship investment research product, Innovation Investor. We’re playing “defense” against this market volatility by adding those hypergrowth tech stocks to our portfolio.

In fact, already in 2022, we bought six brand-new stocks of that ilk — tech stocks that we believe are positioned for both huge near- and long-term gains.

Trust me. These are must-own stocks for 2022 because they’ll deliver great returns and protect you from market volatility. They’ll prove to be winners in a choppy market.

To get their names, ticker symbols and key business details, click here.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.


Article printed from InvestorPlace Media, https://investorplace.com/hypergrowthinvesting/2022/01/the-worst-of-the-selloff-is-over-heres-how-to-spot-winners/.

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