How to Play this Stock Market Dip?

In my last market commentary, I talked about how stocks were falling short of regaining important ground above 4,400 for the S&P 500 (SPY).

Amazingly Wednesday we broke above with gusto...and then gave it all back and then some on Thursday closing at 4,376.

We will explore why this happened and where we head from here in the commentary below...

Market Commentary

The popular narrative for breaking back above 4,400 on Wednesday is that bond rates finally fell in a meaningful fashion from their recent peak. This improves the value equation for stocks with some hopes that this recent pullback was over.

Flash forward to Thursday. No news to speak of while bond rates were little changed. Stocks even started the session in the plus column. And yet tick by tick the gains frittered away leading to a dreadful -1.35% showing.

Not even beloved NVIDIA providing another breathtaking earnings beat could save the day. This begs the question...what the heck just happened?

The answer is: WELCOME TO THE NEW TRADING RANGE

Meaning 4,600 was too high for stocks. And the recent retreat nearer to 4,300 was too low. So now we are going to bounce around in a trading range for a while. This is not a surprise to anyone reading my recent commentaries citing that 4,600 was a bit too lofty given current fundamental conditions.

Trading ranges = erratic price action

That is because a new equilibrium has been established as investors await more clues that would have them become more or less bullish. But the vast majority of the time, the next move after a trading range is to get back to what you were doing before. In this case that means another leg higher.

The most important thing to appreciate about trading ranges is that pretty much all price moves inside the range are meaningless noise. As in, there may not be a logical reason. Case in point being the 1.35% haircut on Thursday.

Let’s get back to the conversation about government bond rates on the rise

There is a false narrative taking place on this vital topic. Some investment journalists are writing that it’s because investors see more long term inflation on the horizon. Yet most signs say that is not true.

Here is what I believe is taking place.

First, let’s step back to remember that since the Great Recession in 2008/2009 the Fed has used every tool necessary to lower rates. That includes Quantitative Easing that led to building a greater than $5 trillion portfolio of Treasury bonds.

That’s because less bonds on the free market = greater demand for the bonds left in circulation = lower rates on those bonds.

Now the Fed wants higher rates. And beyond the aggressive rate hike cycle for the Fed Funds Rate, they have been steadily selling off their bond portfolio (Quantitative Tightening). That leads to this equation:

More bonds on the free market = less demand for the bonds in circulation = rates need to rise to attract additional buyers.

Let’s also remember that the historical average for the 10 year Treasury rate is a little over 4% when the average inflation rate during those periods were a touch over 2%.

So perhaps all that is happening now with higher rates is that they are less manipulated by the Fed...and that they are returning to a true market rate.

That is also why I don’t think rates will go too much higher because looking out to the future inflation will get back to normal...and Fed funds rate will be lower...and thus bond rates will not need to be much higher than now.

Lastly, once the Fed wins their battle over inflation, they will lower the Fed funds rate which will allow the economy to grow faster. This equates to higher corporate earnings growth which is a much more natural catalyst for share price appreciation.

Putting it altogether, we are still in the midst of a new bull market...but one that got out of the gate a little too hot for the tue state of the economic conditions. This leads to the trading range scenario we are in now.

We will break higher once investors are more convinced that the Fed has tamed inflation without causing a recession (aka Soft Landing). This tells everyone that rates will go lower in the future which is a green light for stock advancement.

Bottom Line: Buy the recent dip...and don’t sweat too much of the day to day volatility inside the trading range.

What To Do Next?

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Wishing you a world of investment success!

Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return

SPY shares were trading at $441.03 per share on Friday afternoon, up $4.14 (+0.95%). Year-to-date, SPY has gained 16.19%, versus a % rise in the benchmark S&P 500 index during the same period.

Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.

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