VIDEO: Reasons For Investor Optimism (No, Really!)

Welcome to my latest video presentation. Below is a condensed transcript; my video contains additional details and several charts.

The U.S. Federal Reserve dominated the financial news last week and the reverberations were felt around the globe. The Fed hiked its policy rate by another 75 basis points (0.75%) and signaled a continuation of restrictive monetary policy.

Foreign central bankers are emulating the Fed’s tightening, raising the odds of a worldwide economic slowdown. The summer rally disappeared, with stocks revisiting bear market lows.

Interest rates are now at their highest level in more than a decade, and as Fed Chief Jerome Powell indicated last week, they’re about to get even higher.

Market selloffs are never fun, and I wouldn’t blame you for feeling considerable anxiety right now. But conditions underlying last week’s rout provide legitimate reasons for optimism. First, let’s review last week’s carnage.

For the week, the major indices posted the following declines: the Dow Jones Industrial Average -4.0%; the S&P 500 -4.6%; the technology-heavy NASDAQ -5.1%; and the MSCI EAFE -3.1%. EAFE is an acronym for Europe, Australasia, and the Far East, the most developed areas of the world outside of North America. Crude oil prices fell by -7.1% and the 10-year Treasury yield rose to 3.68%.

Now let’s review the bullish signs.

We appear to be heading for what the technicians call a “double bottom.” A double bottom is a charting pattern that depicts a change in trend and a reversal of momentum from previous leading price action. It describes the drop of a stock or index, a rebound, another drop to the same or similar level as the original drop, and finally (here’s the good news) another rebound.

The double bottom appears like the letter “W,” and the twice-touched low is viewed as a support level, and the launch pad for a bullish upward trajectory.

The Fed has been aggressively hawkish, but I think we’re closer to the end of the tightening cycle than the beginning.

Historically, when the Fed’s policy rate peaks, market performance is robust in the 12- and 24-month periods that follow. Keep in mind, it’s the earlier stage of the rate hike cycle that generates the most negative market reactions.

The expectations game…

It’s always dangerous to project your own interpretations onto the often contradictory utterances of Fed Chair Powell, but by staking out an “uber-hawk” position to prove his toughness on inflation, Powell left the door open for pleasant surprises down the road.

Inflation is showing signs of peaking. If these signs continue, the central bank will have elbow room to get less restrictive.

Recessions are unpleasant, but the silver lining is that a substantial economic downturn would probably prompt the Fed to pivot. We won’t get a dovish pivot in 2022, as originally hoped, but it could occur in 2023, which would boost equity markets.

Also unpleasant are bear markets, but they’re not uncommon, nor are retests of their lows. Historically, over the past 50 years, stock market performance has been strongly positive in the 12 months after a bear market re-tests its lows.

Bond yields have been surging but it appears that the majority of the rise has taken place. After yields peak, stock and bond returns typically benefit.

What’s more, the average post-World War II bear market has lasted about 11 months. At the age of nine months, this current bear market is getting long in the tooth.

The week ahead…

For these aforementioned factors to have traction, we’d need to see market capitulation, i.e. investors reaching complete despair and throwing in the towel. Are we there yet? It’s too soon to say, but economic data in the week ahead will provide important clues.

In coming days, keep an eye on the following: S&P Case Shiller U.S. home price index and consumer confidence (Tuesday); pending home sales and another Powell speech (Wednesday); initial jobless claims and U.S. gross domestic product revision (Thursday); personal consumption expenditures (PCE) index, consumer spending, and inflation expectations (Friday). The big data point will be PCE. If it comes in hotter than expected, watch out.

Editor’s Note: Want to mitigate the risks I’ve just described, without sacrificing performance? Turn to my colleague Jim Fink, chief investment strategist of Velocity Trader.

In a new Investing Daily video, Jim Fink reveals how he hit 626 winners in 647 closed trades. What’s even more amazing is that Jim’s unshakable strategy worked as well during our last bull market…as it did during the pandemic-induced crash…and as it’s still doing today. Click here for details.

John Persinos is the editorial director of Investing Daily.

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