Stock Market Chop and Toss The S&P 500 (SPY) had a nice bounce and remains above its key level. However, the market faces some serious challenges in terms of inflation, a hawkish Fed, and now...

The S&P 500 (SPY) had a nice bounce and remains above its key level. However, the market faces some serious challenges in terms of inflation, a hawkish Fed, and now a possible slowdown in growth. Read on to find out how we are navigating this tricky market environment.

We've seen a deterioration of market conditions over the last week with some ominous developments.

The S&P 500 has managed to stay above its late-February low of 4,100. In contrast, the Nasdaq and Russell 2000 both undercut these levels over the past couple of days, increasing concern that a re-test and possible break lower was imminent for the S&P 500. Today, we got a nice relief rally with the Nasdaq and Russell 2000 closing above these key levels. While this was a positive development, we are still in "no man's land'.

Overall, the market remains in its choppy, muddled state. Today's commentary will entail some brief thoughts on the market outlook and check-in on how Q1 earnings season is shaping up. Then, we'll look at the few trades that are working in this market. And, we'll conclude with a discussion of our portfolio.

Market Commentary

First, let's review the past week…

Over the past week, the S&P 500 is down 2.5%, although it was down 5.3% at its trough. There was more weakness in the Russell 2000 which was down 3.7%, but the Nasdaq was an outperformer with a 2.3% loss, aided by nice post-earnings gains from Facebook and Microsoft.

(As I write this, the Nasdaq is down more than 2% due to post-earnings selling in Amazon and Apple.)

I think this type of performance and volatility is further confirmation that the market is still confined by these choppy conditions.

A couple of weeks ago, I started to get optimistic that maybe all the bad news was priced in and that the market's dip, following the 10% rally in March, could be a launching point for the bull market to reassert itself.

This turned out to be incorrect.

This bullish setup failed, and we are back to a more defensive position. As noted before, a break below 4,100, and we would get to a neutral position as this would indicate that the market's intermediate-trend is lower.

Bullish and Bearish Scenarios

To recap, I see the short-term trend as now being down and the intermediate trend's direction is being tested.

In tennis, they call the space between the service box and the baseline – "no man's land' because this is the worst part of the court to be standing. You either want to be close to the net or behind the baseline.

Similarly, the market is kind of in a place, where it's hard to have confidence about its near-term direction. We are very oversold with bearish sentiment, but there's not really any catalyst to rally. Further, it's easy to see weakness at least until the next FOMC meeting in early May, where traders are looking for either a 50 or 75 basis points hike.

Earnings Season

So far, Q1 earnings season has continued to be better than expected on an aggregate basis. Overall, we have 6.6% earnings growth, while analysts were looking for 4.7% prior to the start of earnings season.

20% of the S&P 500 has reported with 79% of companies topping earnings expectations and 69% beating on revenue. Due to earnings growth and a lower S&P 500, the forward P/E has declined to 18.6 from the mid-20s a few months ago. Another positive is that we are seeing earnings growth across multiple sectors.

The bigger stories to watch with earnings season is seeing what type of impact is felt by inflation and if it starts affecting margins. Another is to see if there are any signs of a slowdown in the economy.

So far, margins have remained pretty strong at 12.3%. This is off from the recent peak of 12.8% but still above historical averages. And, the revenue and earnings beats in multiple sectors are not consistent with the economy slowing.

Still, I can't help noticing a certain flavor of "sell the news, buy the rumor' in stocks that report strong numbers that see an initial pop and then selling to finish lower. One interpretation is that investors are expecting earnings to contract due to higher rates and a possible slowdown.

What's Working

Despite Thursday's big bounce, I still think that we have to respect the downside risk.

Simply put, the Fed is getting increasingly hawkish to the point that it's clear that they are OK with lower stock prices or higher unemployment if that's what is necessary for price stability.

This means that the market is going to be even more sensitive to any data that indicates a slowdown in growth or even a recession is increasing odds.

And, there are some indications that some softening is on the horizon based on leading indicators like the ISM New Orders. Another concern is that China's economy is essentially shut down with mobility and activity levels that were last seen in early 2020.

Therefore, we still need to respect the bear case, however, I did want to talk about briefly what trends and trades are working in the market.

The biggest winners have been the "boring but safe' stocks that are of the high-quality variety. This is why some of the outperformers in 2022 have included defense stocks, consumer staples, utilities, managed care, and pharmaceuticals.

These stocks' earnings and revenue are less impacted by changes in economic or monetary conditions. They have strong pricing power to provide protection in an inflationary environment. They also have a strong balance sheet which provides protection in the event of a downturn.

Another area to monitor is energy and materials stocks. These have also had spectacular runs over the past year which continued in 2022 but have had pullbacks that seem healthy so far. However, I'm less enthused about this theme at the moment given their spectacular gains and the aforementioned data showing a slowdown is likely.

Finally, the travel trend is taking off. We are seeing strong earnings reports and very positive commentary from management teams. So far, the stocks haven't reacted too much, but I'm confident that this will be a leading group once the bull market reasserts itself.

Now, let's shift our focus to the portfolio…

Nexa Resources (NEXA)

NEXA shares were 7% higher following the company's earnings report.

Due to its strong report, the company's forward P/E is now 4. It reported $0.48 in EPS, topping estimates, and a big improvement from last year's $0.17 per share in earnings.

Given its strong results and low valuation, this is a cyclical stock that I'm willing to hold onto.

Trivago (TRVG)

Here is an article I wrote about TRVG.

Centerra Gold (CGAU)

In contrast to NEXA, CGAU is a commodity stock that I'm less into given that real interest rates are starting to rise.

In my experience, gold prices have a tough time breaking out to new highs when this is the case. And, the last few months have been great for gold as inflation was raging higher, the geopolitical risk was exploding, and the Fed was slow to act.

Now, the Fed is quite hawkish, but it seems that inflation may be plateauing which means real rates should start trending higher.

.Garrett Motion (GTX)

GTX reported earnings that came in below expectations due to decreased production from automakers.

Q1 was likely the nadir of supply chain issues, and we should see auto production improve from here. Thus, it's not surprising that GTX's stock price was unchanged as investors are more focused on the future and have already priced in its current set of challenges.

Overall, I think it was still a good result with $88 million in net income in a depressed quarter. This is especially impressive considering that the overall market cap for GTX is $450 million.

Lincoln Education (LINC)

Also did a write-up on LINC, here.

Summary

Last week, I wrote:

For us, the bigger picture is on managing risk if we fall below our key levels. The first key level is around 4350 on the S&P 500. After that, it's the 4,100 level for the intermediate-term trend.

The first key level was broken, and we raised some cash. Now, we will watch to see how the market acts around the 4,100 level and what it does going into next week's Fed meeting.

All the Best!

Jaimini Desai
Chief Growth Strategist, StockNews
Editor of the POWR Stocks Under $10 Newsletter

SPY shares fell $3.84 (-0.90%) in premarket trading Friday. Year-to-date, SPY has declined -9.65%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini's background, along with links to his most recent articles.

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