With Recession Risk Rising These Sectors Should Outperform the Broader Market
In a not very surprising turn of events, the bear market bounce has failed as we've given up more than half of its gains. I, think it validates our decision...
In a not very surprising turn of events, the bear market bounce has failed as we've given up more than half of its gains. I, think it validates our decision to sit on our hands. Another validation is weakness in energy and cyclicals - a dip that I am not interested in buying. As we discussed last week, inflation risk is receding, while recession risk is rising. Today's commentary will dig into this dynamic and look at the broader S&P 500 (SPY). Then, I'll discuss my strategy, sectors I like, and the right setup to take counter-trend positions. Read on below to find out more….
(Please enjoy this updated version of my weekly commentary published June 30th, 2022 from the POWR Stocks Under $10 newsletter).
The S&P 500 (SPY) is basically flat over the last week. However, this masks the fact that there was a lot of volatility as stocks were up nearly 7% by Tuesday’s close before reversing these gains over the last 2 sessions.
Again, this is simply what happens in bear markets.
In terms of narratives, the bounce was due to some signs that inflation is easing. This included the drop in commodity and energy prices in addition to the accumulation of other factors which we have been documenting.
It’s becoming increasingly evident that inflation has peaked or is close to peaking.
In a vacuum, this is bullish. In this instance, I don’t think it’s bullish, because it’s going to come at the expense of corporate earnings.
Going back to our earlier discussion on what are the major movers of stock prices – earnings and interest rates. Until a month ago, we had the dynamic of rates spiking higher, while earnings continued to defy skeptics and grow – 7% in Q1 and 4% in Q2.
Inflation peaking means that the bearish force of higher rates becomes neutered. In fact, we could see longer-term rates back off which could be one reason for outperformance in certain sectors (more on this later).
So yes, even though, I think another leg lower is likely, I think we will find more opportunities on the long side.
Strategies for this Market
First of all, given the bear market, we are holding large amounts of cash and defensive positions.
The latter is a particular challenge for the POWR Stocks Under 10 service because most stocks under $10 are very risk-on.
This was the logic behind our precious metals position which has been dragged lower due to weakness in the commodity complex.
Instead, the defensive stocks that are working are aerospace & defense stocks, pharma and biotech, and utilities. Again, these are not the type of stocks that are typically found under $10.
The bigger point is that stocks under $10 are very sensitive to liquidity. And, liquidity is anathema during a bear market when recessionary conditions dominate and the Fed continues to hold a hawkish stance.
Therefore, we have to continue to prioritize risk management over chasing returns. And, we have to embrace going for singles and doubles rather than home runs.
Kind of spoiled it already. But, we are seeing some strength in certain pockets of the market (SPY).
In terms of stocks under $10, I’m most interested in the healthcare industry, specifically pharmaceuticals and biotech stocks.
This sector has underperformed since 2015. But, growth has been solid. The result is that the group went from being among the most expensive in 2015 to one of the cheapest, today.
Of course, the long-term fundamentals are still intact – increasing government spending on healthcare, an aging population, and healthcare costs rising faster than (long-term) inflation.
Waiting for the Right Setup
Finally, when is it time to actually pull the trigger?
Ideally, we will get some sort of capitulation in the market. This would be a large move lower that spikes fear and lead to all sorts of positions being liquidated through margin calls. This would be the all-clear to get back into the market (SPY) and feel confident that either the bear market is over, or that a multimonth, bear market rally was about to begin.
Of course, the market rarely delivers exactly what we want. Another setup I would feel comfortable getting long is similar to mid-March when we were re-testing recent lows with several positive divergences in terms of credit, breadth, and risk appetites.
I would be willing to marginally increase exposure if this were to materialize.
What To Do Next?
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All the Best!
Chief Growth Strategist, StockNews
Editor, POWR Stocks Under $10 Newsletter
SPY shares were trading at $375.47 per share on Friday morning, down $1.78 (-0.47%). Year-to-date, SPY has declined -20.36%, 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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