Ever since the markets put in their key upside reversal on October 13, stocks have been on a tear.
On that day, the S&P gapped lower on the open and proceeded to fall by -2.39% at its worst, before quickly heading back up. Within the hour, stocks turned positive. And by day’s end, they closed with gains of 2.60%.
(A key reversal is characterized by an open that’s below the previous day’s close, it then makes a new low, and the close must be above the previous day’s high.)
All of the major indexes made key reversals on that day, which includes the Dow, the S&P, the Nasdaq, and the small-cap Russell 2000 index.
Key reversals are relatively rare patterns, and are usually considered reliable.
Since then, stocks have soared.
What prompted the turnaround?
Quite frankly, after 3 quarters in a row of falling stock prices, and endless stories of doom and gloom, it appeared as if all of the bad news might just have been priced into the market already. And now it was time to go higher.
So What Changed?
For one, the recession of 2022 has come and gone.
After Q1’s GDP shrank by -1.6%, traders were expecting the worst, predicting a deep recession was coming.
That was followed by Q2’s -0.6%.
But all the while, consumer demand remained strong. So did corporate earnings. And the jobs market stayed sizzling hot.
Suddenly, the worst-case scenario no longer looked like it was going to happen.
Forecasts for the second half were calling for growth.
And in Q3, GDP grew by a robust 2.6%. (It’s no longer a recession when the economy starts growing again.)
GDP forecasts are pointing to plus signs for the rest of the year.
And the Federal Reserve Bank of Atlanta, via their GDP Now forecast, is estimating Q4 GDP to come in at 4.2%.
The recession is clearly behind us. And the outlook is for growth.
Have We Finally Seen Peak Inflation?
Last week, the Consumer Price Index (CPI) inflation report came out with a better than expected reading.
Instead of the previous month’s 8.2% y/y headline rate, it came in at 7.7%. Not only was that down from the previous month, it has consistently fallen from its summer high of 9.1%. Same for the core rate (ex-food & energy), which came in at 6.3% y/y vs. the previous month’s 6.6%.
That was further underscored by last Tuesday’s Producer Price Index (PPI) report, which also came in better than expected: the headline rate was 8.0% y/y vs. last month’s 8.5% and views for 8.3%; while the core rate was 6.7% vs. last month’s 7.2% and views for the same.
Of course, inflation is still too high.
And the Fed is not done raising rates. Nor should they be. High inflation is far worse for the economy than higher interest rates.
However, at the Fed’s last FOMC meeting in early November, they already hinted at slowing down their pace of raising rates.
And after the lower inflation readings, it’s looking more and more likely we’ll only see a 50 basis point rise in rates at their December meeting, rather than 75 basis points (like their last 4 meetings in row).
Many are also believing that if inflation keeps falling, their terminal rate (the level at which the Fed stops raising rates and holds them steady for a while), may not need to climb to 5% after all, and instead hover nearer their 4.6% target they had forecast back in September.
If so, that would only require 1 more increase at their February meeting of 25 basis points to reach that level and be done.
More . . .
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Are Stocks Undervalued?
Let’s also not forget that valuations are down.
In fact, the P/E ratio for the S&P is trading at multiyear lows, and below its five-year average.
And that makes stocks a bargain.
Of course, if earnings drift lower, valuations will become higher. But there’s plenty of room for stocks to remain relatively cheap.
And the earnings outlook is still forecasting growth.
In fact, this earnings season (which is still going on, but winding down), has come in better than expected. And stocks have responded accordingly.
Seasonality Is On The Market’s Side
It also doesn’t hurt that stocks typically go up after midterm elections.
Many are familiar with the Presidential Cycle and the markets. But many may not know that the Presidential Cycle covers all four years of a presidency.
Of particular interest is the midterm portion of the cycle, which is where we are right now. While midterm elections just finished, that marks the beginning of the midterm effect on the markets.
And historically, it’s amazing to see how favorable this cycle is for investors.
In fact, we’re entering the most bullish part of the cycle; Q4 of year 2 in the 4-year Presidential Cycle, is the second-strongest quarter of all 16 quarters; while Q1 of year 3 is the strongest quarter of all 16 quarters.
So we are literally at the beginning of one of the most bullish periods for the market.
Since 1950, there have been 18 midterm elections, and stocks have gone up the following year 100% of the time.
From 1950 to 2018, the average 12-month forward returns are 18.6%.
That being the case, it should also come as no surprise that the third year in the Presidential Cycle (that would be 2023), has historically been the best year of all four years.
So not only are we at the beginning of the 2 best quarters for stocks, we are at the beginning of the best 15 months for stocks.
But, What If...?
To be fair, the economy has its problems.
Some are still calling for a recession (even though we just came out of it).
And who can forget Jamie Dimon’s call for an “economic hurricane?”
Although, earlier this year, he also said that he thinks the U.S. is headed for the best economic growth in decades, and that the “consumer balance sheet has never been in better shape.”
So, he’s definitely putting out some mixed messaging.
But that’s why big announcements like this all have to be taken with a grain of salt – both the bullish ones and bearish ones.
I’m not dismissing the possibility of problems down the road.
But his ominous ‘hurricane’ statement instantly remined me of the ‘irrational exuberance’ line from Fed Chair, Alan Greenspan, back on December 5th, 1996.
From the time of that speech, the S&P gained over 105% before peaking on March 24th, 2000 (more than 3¼ years later).
Just imagine all of the money someone would have missed out on if they had jumped ship the moment he made that comment.
Do What Works
So how do you fully take advantage of the market right now?
By implementing tried and true methods that work to find the best stocks.
For example, did you know that stocks with a Zacks Rank #1 Strong Buy have beaten the market in 28 of the last 34 years (an 82% win ratio) with an average annual return of 25% per year? That's more than 2 x the S&P. And consistently beating the market year after year can add up to a lot more than just two times the returns.
And did you also know that stocks in the top 50% of Zacks Ranked Industries outperform those in the bottom 50% by a factor of 2 to 1? There's a reason why they say that half of a stock's price movement can be attributed to the group that it's in. Because it's true!
Those two things will give any investor a huge probability of success and put you well on your way to beating the market.
But you’re not there yet, as those two items alone will only narrow down a field of 10,000 stocks to the top 100 or so. Way too many to trade at once.
So, the next step is to get that list down to the best 5-10 stocks that you can buy.
Proven Profitable Strategies
Picking the best stocks is a lot easier when there’s a proven, profitable method to do it.
And by concentrating on what has proven to work in the past, you’ll have a better idea as to what your probability of success will be now and in the future.
Of course, this won't preclude you from ever having another losing trade. But if your stock picking strategy picks winners more often than losers, you can feel confident that your next trade will have a high probability of success.
Here are a few of my favorite strategies that have regularly crushed the market year after year.
New Highs: Studies have shown that stocks making new highs have a tendency of making even higher highs. And this strategy proves it. The alignment of positive price action and strong fundamentals creates all the necessary conditions to see these stocks soar to even greater heights. Over the last 22 years (2000 through 2021), using a 1-week rebalance, the average annual return has been 43.2% vs. the S&P’s 7.5%, which is 5.7 x the market.
Small-Cap Growth: Small-caps have historically outperformed the market time and time again. Often these are newer companies in the early part of their growth cycle, which is when they grow the fastest. This strategy combines the aggressive growth of small-caps with our special blend of growth and valuation metrics for explosive returns. Over the last 22 years (2000 through 2021), using a 1-week rebalance, the average annual return has been 50.4%, beating the market by 6.7 x the returns.
Filtered Zacks Rank 5: This strategy leverages the Zacks Rank #1 Strong Buys, and adds two time-tested filters to narrow the list of stocks down to five high probability picks each week. Over the last 22 years (2000 through 2021), using a 1-week rebalance, the average annual return has been 51.2%, which is 6.8 x the market.
The best part about these strategies (aside from the returns) is that all of the testing and hard work has already been done. There’s no guesswork involved. Just point and click and start getting into better stocks on your very next trade.
Where To Start
There’s a simple way to add a big performance advantage for your stock-picking success. It's called the Zacks Method for Trading: Home Study Course.
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You'll quickly see how to get the most out of the proven system that has more than doubled the market for over three decades. Discover what kind of trader you are, how to find stocks with the highest probability of success, and how to trade them so you can consistently beat the market no matter where stock prices are headed.
You’ll get the formulas behind our top-performing strategies suited for a variety of different trading styles.
The best of these strategies produced gains up to +48.2%, +67.6% and even +95.3% in 2021.¹
The course will also help you create and test your own stock-picking strategies.
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Thanks and good trading,
Zacks Executive VP Kevin Matras is responsible for all of our trading and investing services. He developed many of our most powerful market-beating strategies and directs the Zacks Method for Trading: Home Study Course.
¹ The results listed above are not (or may not be) representative of the performance of all strategies developed by Zacks Investment Research.
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