A Brutal Reversal for the Stock Market…

The S&P 500 wiped out its post-FOMC gains in a brutal, bearish session on Thursday. Read on to find out the right gameplan for this market environment, including an endgame for the correction and a sector that continue to offer upside.

(Please enjoy this updated version of my weekly commentary published May 5^th, 2022 from the POWR Stocks Under $10 newsletter).

On Wednesday, stocks floated higher with a more than 3% gain.

Today, we unwound those gains and more. The S&P 500 finished with a 3.5% decline, while the Nasdaq and Russell 2000 lost 5% and 4%, respectively. (And this was after a late-day 1% rally).

Currently, we are about 1-2% above Monday’s lows which are also our 2022 lows. A break below these obviously brings more downside risk. Unfortunately, this is the reality of these choppy and bearish conditions.

In today’s commentary, I want to discuss what is happening, and a possible endgame for this correction. Next, I want to dive deeper into the current market environment, and why exactly it’s so challenging. Finally, I want to talk about one theme that I continue to like and then dig into the portfolio.

Market Commentary

First, let’s review the past week…

Over the past week, the S&P 500 is down 3.7% with more weakness in the Russell 2000 and the Nasdaq. The Nasdaq was the loser of the bunch as many high-profile tech stocks have sold off by double-digits following their earnings reports.

The bigger development is that all the major indices broke below their late-February lows with 4,100 for the S&P 500 is our premier level. We did have a nice, 4%+ rally from Monday’s lows, but the bulk of these gains was wiped out in today’s trading session.

Will These Lows Hold or Are We Going to Breakdown Further?

This is the question on the minds of most market participants.

[Let’s start with the caveat that this is an area that I (and everyone else) have or should have a low conviction on, so we will not be making aggressive moves based on these hunches.]

One difference this time vs when the market was falling in January and February is that there were pockets of outperformance in sectors like materials and energy. This time, such opportunities are much more rare.

And, where they are found is in very defensive sectors like utilities, pharmaceuticals, and consumer staples. Needless to say, the universe of low-priced stocks doesn’t include very many names in this group.

Another factor is that sentiment has reached very bearish levels that correspond to market reversal.

Let me sum it up this way… if this is a normal market and a normal correction, then we should bounce very soon and with gusto. If this weakness is due to a more systemic issue, then all bets are off, and we should patiently wait for some sort of capitulation event before getting more aggressive on the long side.

Another possibility or theory that ‘fits the evidence’ is that we have some sort of fund liquidation going on, probably in the tech world due to heavy losses in overvalued and overowned stocks like Carvana, Shopify, or Cloudflare. There is some speculation that it could be Tiger Global and its satellite of funds which is down 44% YTD.

This forced selling or potential of forced selling leads other traders to short these stocks, pushing prices down even lower… a bunch of Wall Street sharks circling a wounded fish.

These events tend to happen at inflection points and could be a good trigger to enter long positions.

Challenges of the Correction

One reason that this correction has been so challenging is that we are having two different bearish impulses.

The first is inflation and higher rates. The bulk of this pain has already worked its way through the market. Interestingly, on this leg lower, I am noticing some relative strength in the sectors that led us lower.

But the markets are still down because now we have a second bearish impulse in terms of the market getting worried about economic growth and the potential for a recession. To be frank, I don’t see it yet in the data, but no one can argue that leading indicators aren’t weakening at a concerning pace.

This is an important distinction and one reason that the nature of the selloff has changed.

Energy

We have spent a lot of time and thought on energy, and it’s been a remarkably successful trade.

Since Russia’s invasion caused oil to spike to $135, prices backed off and are now range-bound.

I am surprised and impressed by this resilience especially considering that large parts of China’s economy have been under lockdown for much of the past month.

Further, I have been reading up on stocks in areas like offshore drilling and uranium that have considerable upside and could be the next batch of leaders in this energy bull market.

Nothing has really changed in terms of energy’s fundamentals, other than marginally improving as a deal with Iran seems to have fallen apart, and Europe is moving ahead with plans to get off Russian energy. So, energy remains bullish, and the fundamentals keep improving. We will certainly be increasing exposure to this group in the coming weeks.

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All the Best!

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

SPY shares fell $0.51 (-0.12%) in premarket trading Friday. Year-to-date, SPY has declined -12.60%, 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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