Opinion: The stock market has likely entered a new uptrend — so you’ll want to own these five stocks

That didn’t take long.

The decline in the S&P 500 SPX,
and Nasdaq Composite Index COMP,
After their meteoric rise from the mid-June lows, many market commentators are asking two key questions: Was this a false bear market rally? Will the market review the lows and go lower?

My answers: No and no.

I argue that we are in the early stages of a new bull market, which means you should buy any significant weakness like what we are seeing now. I don’t mean to dismiss the skeptics. We need them. After all, a key component of any bull market is the “wall of worry.”

You always need large groups of people worrying about this and that, and predicting the market and the financial crash, for a bull market to survive. Here’s why: Once everyone is bullish, there are no more people out there turn bullish and push stocks up.

Of course, I may be the one to be proven wrong. But here are five reasons why we’re in a new bull market phase, and five stocks that will likely outperform during this time.

Reason #1: High inflation is really temporary

Market bears tell us that inflation will remain high, forcing the Fed to raise interest rates high enough to trigger a severe recession. They will be wrong. But you can see how they would make that mistake.

First, a basic flaw in forecasting is the habit of assuming that current conditions will persist. Second, it takes some time for reductions in inflation to pass through to consumer prices and headline inflation data such as the consumer price index (CPI). Before we get to how long it takes, consider all the really good news about upstream inflation that is simply being ignored because it hasn’t caught up to core inflation yet.

* The S&P Goldman Sachs commodity price indexes for agricultural and energy products have recently fallen 18%-20% from May and June peaks.

* Fares fell by a third from recent highs.

* The prices companies are paying clearly peaked earlier this year, according to the latest business surveys from the Federal Reserve Bank of New York, Philadelphia and Richmond. They also displayed lead times and outstanding contract orders prominently. This tells us that supply chain problems – a big source of inflation – are easing.

* New-car production in July rebounded to late-2020 levels, which will put more downward pressure on used-car prices, which are already in decline — down 3.6% in the first half of August.

I could go on. But the main point is that little of this has appeared in headline inflation indicators. Thus, the bears remain unconvinced and bearish.

The next big inflation report will be the August CPI, which will be released on September 13. It will show a limited impact of the decline in upstream inflation. A recent Goldman Sachs study says upstream costs take two to six quarters to affect nominal price measures. We’re not there yet. But we will have lower inflation numbers that calm the bears, persuading them to become more bullish and buy our stocks.

Reason #2: Consumer confidence will rebound

We all know that consumers drive most of our GDP growth — two-thirds or more. Right now, consumer sentiment is very low — recently at a post-WWII low. This seems strange given that the job market is so strong. But consumers watch prices closely and when they see them rise too much, they turn negative.

Likewise, as inflation recedes, consumer sentiment will increase. This will turn consumer sentiment more positive, unleashing animal spirits and spending.

Stocks will respond. Despite the attention given to Fed tightening, consumer confidence is having a bigger impact on the stock market. There is a close correlation between rising confidence and stock market gains. This is the indicator to watch. Consumers also have room to borrow, despite rising loan balances. Debt servicing costs and household leverage remain well below historical averages.

Reason #3: A recession is unlikely

I’ll skip the highly politicized and silly debate about “what is a recession” as the definition has been clear for years. The National Bureau of Economic Research (NBER) decides and takes into account many factors beyond GDP, including the strength of employment.

The NBER is unlikely to determine that there has been a recession for one simple reason: Employment is too strong. Payroll employment rose each month in the first seven months of 2022 by 3.3 million jobs to a record 152.5 million in July. We usually don’t have a recession when the labor market is this strong. Retail sales rose 2.4% on a quarterly basis in July — another sign of no recession.

Of course, strong employment is a double-edged sword. When unemployment levels are this low – around 3.5% – recessions can follow. The labor market is so tight that companies can’t find more workers to keep growing. This time, however, the labor participation rate remains subdued. More people going back to work would buy us time in this expansion.

Even if it doesn’t, the big picture, we’re seeing an absence of the excesses that usually contribute to bad recessions — like the tech bubble of the late 1990s or the mortgage bubble of 2005-2007. So even if we have a recession, it may be mild. As for those two back-to-back cuts to GDP that the politicians are making — the jury is still out on that one. This data could be significantly revised upwards. It’s already happening.

Reason #4: Covid is on the run

Covid has been sneaky, so no one knows if it is actually going away. But so far, at least, no new variant of Covid is in the wings to take over from BA.5. So many people have built up natural immunity from being infected with Covid, any new variant may struggle to gain traction.

We’ll know more when the cold weather hits in October and November. But if this good fortune holds, it will be bullish for the economy. It means more people will travel, increasing spending on accommodation and restaurants.

More importantly for the global economy, a slowdown means China will end lockdowns more decisively, setting up a relaunch of the recovery there in the second half of the year. This will support global growth. Yes, July’s data showed that China’s economy was weak. However, the People’s Bank of China recently cut key interest rates unexpectedly, by a token amount. The reversal tells us that it is open to more rate cuts. Meanwhile, China’s Premier Li Keqiang recently urged provinces to boost fiscal spending.

Reason #5: Sentiment has bottomed out

Investor sentiment hit extreme lows in mid-June – the kind of lows that occur around key market bottoms. Emotion is hard to pin down—partly because you also have to watch yourself. But one gauge I use as a handy shortcut is the Investors Intelligence Bull/Bear Ratio.

It fell to around 0.6 near June market lows. This is a capitulation, suggesting that investors have given up and given up – as they usually do at market bottoms. The June reading was the lowest since March 2009, the market low in the last bear market. The bull bear indicator reached 0.56 the week of March 10, 2009, and the stock market bottomed that week on March 11.

The good news here is that the bull/bear ratio remains low at 1.52. Anything below 2 tells me the market is overbought, from how I use this gauge.

The bottom line

Given all the persistent fears about inflation, the Fed and recession, it’s no surprise that investors remain so pessimistic. Instead of joining the bearish crowd as stocks retreat, think of this as the classic “wall of worry” buyer that all bull markets must climb.

In this environment, it makes sense to buy stocks — starting with names that have moats but look cheap because they have a four- or five-star rating (out of five) on Morningstar Direct.

Alphabet GOOGL’s downtrodden FAANGs,
Amazon.com AMZN,
and Meta META,
all fit the bill, as did JP Morgan JPM,
and Nike NKE,
For more on this approach to stock picking, see this column of mine.

In the short term, we may see weakness in September. It’s historically the worst month for stocks. It’s also the month the Fed steps up its quantitative tightening. So, as always, it’s best to plan stock purchases in phases.

Michael Brush is a MarketWatch columnist. At the time of publication he owned GOOGL, AMZN, META and NKE. Brush has recommended GOOGL, AMZN, META, JPM and NKE in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.

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