TM Editors' note: This article discusses a penny stock and/or microcap. Such stocks are easily manipulated; do your own careful due diligence.

There was an abundance of earnings announcements this past week, as well as updated economic information. Can we evaluate how healthy companies are from their earnings announcements? Can we interpret the state of the economy from this information? Let’s explore.

Last week we provided many reasons why we thought the market could continue to climb higher or climb the wall of worry. The beginning of the week looked shaky from negative expectations surrounding upcoming tech earnings. We witnessed a couple of heavily negative days. Some traders suspected we had finally broken out of the sideways malaise and that the S&P 500 was headed south. Not so fast.

Recall some of the reasons that the market might continue higher. Here is a refresher:

1. The PMI (Purchasing Manager Indicator) had turned up.
2. Other economic indicators were looking more positive.
3. The number of S&P (and NDX) stocks over their 50-day moving averages were increasing.
4. Negative sentiment readings increased, as well as large positions of puts being held by traders. This could trigger a short covering rally (we suspect it may have contributed to Thursday’s big day up).
5. Active investment managers are putting money to work and have committed more cash to stocks (less cash holding by institutional managers).
6. The 128 days of an overall upward move. That is a positive indicator that the market is on solid ground and can move higher.
7. This is a favorable investment period. November to April (especially in pre-election years) is often a positive period for stocks.
8. The last week of April tends to be good historically.

After a few days of weakness, Thursday began with an economic update on GDP. Forecasted to come in at 2.0% or higher, it surprised everyone by coming in weaker than expected at 1.1%.

Most analysts interpreted this as a slowing (stalling) economy which may help the Fed to pause sooner than later. Bad news was good news. The market celebrated the second best day of 2023.

The S&P finished the week up 1.0%, and the tech heavy QQQ was up a little better than 1%. It was a good week to turn off some of the news (and noise) and stay invested.

The Effect of Earnings Season

Remember this is earnings season, and as we previously pointed out, this was going to be a week where numbers would speak volumes about the state of corporate America.

More importantly, these earnings announcements would also tell us about what the management of corporations are predicting for their future business and the overall economy. There was also a heightened acuity about what might be said on their post earnings announcement conference calls.

A good illustration of the power of these conference calls was best exemplified by Amazon's earnings on Thursday. Their earnings numbers beat (by a wide margin) the analyst expectations. The stock was up in after hours trading by 7-8%, a big move for a behemoth company.

However, what they said in their conference call was negative. They expect a slowdown in the economy will likely have a negative effect on their customers’ use of AWS (Amazon Web Services). AWS historically has been one of the most profitable arms of Amazon. The company's guidance reiterated the slowing GDP number issued earlier in the day. Instead of the stock being up on Friday by 7-8%, the stock closed down 4%.

Good news turned into bad news, which then turned into good news? How can that be? Amazon’s good earnings with negative commentary (bad news) turned into the market interpreting this as the long-awaited corporate earnings slowdown that the Fed has been anticipating. That translated into expectations for a Fed pause or even interest rate cuts later in 2023. The overall market rallied, and bonds had a good day.

What a week of dichotomies.

Multiple companies in the same or similar industries reported very different and contradictory earnings numbers. Some companies reported a huge earnings beat followed by an upbeat conference call (META, MSFT, & XOM). And then their stocks took off.

Other companies reported earnings misses with a pessimistic tone (FSLR & AMZN), and their stocks closed negative or got clobbered (FRC & SNAP). Amazon, as discussed above, was one of the best examples of a company dichotomy. Report good earnings but negative guidance news.

Earnings Update

According to FactSet, 53% of S&P 500 companies have reported their Q1 2023 results, with 79% beating their earnings estimates and 74% reporting revenues above estimates.

Please be aware, however, that all earnings expectations were ratcheted down given the economic slowdown that is occurring coupled with higher operating costs. Most analysts, CFAs, and research houses still believe that the market is selling at a lofty multiple, and they continue to warn that the overall market should be valued at lower prices.

We can’t comment, so we can only offer what Mr. Wonderful says on Shark Tank: “Money always goes to where it is treated best.”

Earnings Expectations

We would also suggest you go back and revisit our pieces that address how to evaluate fair value of the stock market. As you may be aware, I came from a long career with a traditional stock manager who evaluated every stock’s future earnings and conveyed to clients what the earnings might look like in the near future.

A quick formula that works well (and gives an accurate reading) is to apply a reasonable multiple to current S&P earnings. According to Y Charts, the current S&P earnings are $187 (a share), and then multiplied by a fair multiple (we would use historical averages of 17x-20x, especially if we are in a slowdown with elevated interest rates). That current range would be approximately 3179-3740.

Of course, the stock market is forward-looking and is often valued on the growth of earnings and what future earnings might look like two to four quarters out. Using that as our guide, and a very liberal rate of growth of 10-12% in earnings (not likely to happen if we have a slowing economy), that would put estimates at 3800-4200 on the S&P 500. We currently are at 4169. Is there a lot of upside? This is the important question investors need to ask.

Upcoming Apple Earnings This Week

Apple will announce its earnings this coming week. I suspect that it will either propel the market higher or sink it quickly. Most analysts are hoping that Apple can support the good news that other mega-cap technology stocks have experienced so far.

If you are watching for any sign that Apple may deliver the “goods,” please note that Apple stock hit a six-month high on Friday. The chart looks far more positive than negative. Maybe the news they will deliver is already baked in the cake.

In The Danger Zone (Growing Concerns)

We make every attempt to look at the macro environment with a fair and balanced outlook, However, there are meaningful issues on the table at this moment. In some respect I feel that we are in the “Danger Zone” and operating out on the edges.

A popular phrase used among investors and analysts is “the bond market is always right.” If that is so, there is no doubt that the bond market right now is calling for a recession. Earlier in the year, the bond market forecasted a 25 basis point raise.

However, this past week, the PCE (Personal Consumption Expenditure) came in hotter than expected. Faced with persistently high inflation, we now are looking at perhaps not one but likely two more 25 basis point rises. At least that was the takeaway from this past week.

The Fed’s Expectations

The Fed has revised its economic forecasts several times in the past few months. They are now expecting GDP for 2023 to come in at 0.4% (avoiding a recession and indicating a soft landing). If true, with the latest report of 1.1% for the first quarter, we would have to incur negative growth in the economy for the next few quarters.

The Fed is also expecting that their actions will cause unemployment to eventually get to 4.5%, which would mean 1,600,000 workers would become unemployed.

Other Issues

There is a long list of some serious economic and geopolitical risks hanging over the economy at the present time. We state this just so you have a realistic picture of the possible areas that could derail the economy. A few to consider include the following:

• The third largest regional bank collapsed over the past week. First Republic Corp (FRC) will be taken over by the FDIC this weekend. They are hoping that either PNC Bank or JP Morgan will buy the bank’s assets.
• Commercial real estate is showing significant weakness. More than a few large commercial buildings are being taken over by the banks and holders of the loans on these buildings. Some of this was exacerbated by employees not wishing to come back to work in the office setting as well as companies accommodating employees who wish to work remotely.
• Bankruptcies and reorganizations continued to climb. Last week, Bed, Bath and Beyond (BBBY) effectively called it quits. They have hundreds of stores and many leases that will affect smaller strip center owners.
• Credit card debt is rising.
• Delinquent car loans are accelerating.
• CDS (Collateralized Debt Swaps), which are used to insure investments, have climbed dramatically in price.

Too Few Stocks are Driving the Markets

The five largest stocks are responsible for the majority of the S&P 500’s gain this year. In fact, the margin between the market cap weighted S&P 500 and the equal weighted S&P 500 is 5%, the widest gap in 34 years. 2020 saw this gap at 2%, and the only other year that it was better than 2% was 1997. It is important to note that both those years saw a yearly return of greater than 20%.

This narrowing of breadth is a negative on the markets, and it must be resolved soon or the market may soon be facing a nasty correction.

Stagflation

As our own Mish has pointed out on numerous occasions, “we are now faced with one of the worst economic scenarios playing out - Stagflation.” While this is hardly a new idea for us, it seems to have caught on in the press recently. The lead off story this week from Fortune was as follows:

Stagflation is a bad economic condition where unemployment stays stubbornly low, growth rates in the economy are basically non-existent, and inflation continues to erode purchasing power as companies cannot deliver wage gains while they are battling higher costs.

The stock market typically goes sideways in this type of economic environment. Look at 1973 to 1981 for an example of this type of investing environment. It’s the worst of all possible scenarios.

Last Thursday’s data of a slowing economy with a GDP number well below expectations, coupled with the PCE coming in slightly higher than expected, was the worst possible news. To us, it also signals that there will likely be no possible rate cuts by the Fed in 2023.

And Morgan Stanley’s chief U.S. economist Ellen Zentner said on Thursday that after a “modest step down” in economic growth in the first quarter, she is “tracking” second-quarter GDP growth at negative 0.4%. “We expect to see significant slowing into Q2 23 as the cumulative effect of tighter monetary policy as well as banking pressures push growth into negative territory,” she wrote in a note to clients.

How to Invest in this Economic Environment?

This will continue to be a narrow market and one that rewards careful stock picking and risk management. It is important to utilize a trader’s mentality in this type of economic backdrop. Here are additional points of interest to take note of in this current economic environment.

Risk-On

• 3 of the 4 key indices are making multi-month highs and are in bull phases, with the exception of the Russell (IWM) which remains in a bear phase on both a daily and a weekly timeframe.
• The McClellan Indicator has moved back into positive territory after getting moderately oversold for both the S&P 500 and Nasdaq Composite.
• The rally in the one-month vs three-month volatility ratio continues to surge higher along with equities.
• Cash volatility continues to make new multi-year lows, which is a strong bullish indication.
• The number of stocks above key moving averages (10-, 50-, & 200-MA) within the S&P 500 index has recovered back over the 50% level on all timeframes, while the stocks within the IWM remain weak but are recovering and stacked in a bullish array.
• After a bit of sloppy action, bonds (TLT) closed the week in an accumulation phase, and with real motion much stronger and in a bull phase.
• Large-cap stocks (DIA) continue to lead, although there has been some significant improvement in mid-caps which have now closed back above the 200-day MA and in a warning phase.
• Although both growth (VUG) and value stocks (VTV) recovered this week, VUG is now outperforming on a relative basis and has put in its new highest close since September.
• The key thing to watch is regional banks (KRE), which closed above a short-term island gap as well as the 10-day moving average on Friday. If this can remain above the short-term average, it could be a good lead indicator of further strength.
• Both developed and emerging foreign equities (EFA and EEM) are now back in their own respective bull phases on both price and momentum, according to real motion.

Risk-Off

• Despite the rally to end the week and the new multi-month highs for the indices, the 52-week new high new low ratio failed to recover for both the S&P 500 and Nasdaq Composite.

Neutral

• Volume patterns remain weak as they’re sitting in a neutral range at best, with the biggest concern being that there hasn’t been a single accumulation day in the S&P 500 over the past two weeks.
• Despite closing the week slightly negative, the two most interesting sectors appear to be industrials (XLI) and materials (XLB), which both saw their price as well as their short-term momentum cross into bullish phases this week.
• Interestingly, technology (XLK) was relatively strong this week while semiconductors (SMH) got crushed, a strange and divergent market relationship.
• Risk gauges have returned to neutral territory.
• Soft commodities (DBA) is working off overbought readings, while copper looks to be digesting as well but remains relatively strong after bouncing off of its 50-day MA.
• Gold (GLD) continues to digest an overbought reading, with sideways compression being seen on price action.

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