Let’s define a bounce as a thrust higher that rolls over to new lows. And a rally as a move that holds above previous lows and goes on to make higher highs. Obviously, one’s opinion on this question is important when it comes to strategy especially following the strong bounce in the S&P 500 (SPY) from  its Friday, December 3, lows. A bounce would mean it would be prudent to reduce exposure on strength, while the latter would mean it’s prudent to remain fully invested and invest our energy into making sure we are exposed to the best sectors and setups. In today’s commentary, I will make the case that this is a rally and not a bounce. Then identify the best stocks, sectors, and setups.

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The stock market has put together an impressive rally Friday, December 3’s lows. From there, the S&P (SPX) is up 3.8% even after today’s nearly 1% pullback. The Russell 2000 (IWM) is up 3.6% although it’s off 3% from yesterday’s highs.

So, it’s certainly clear that the market has had a nice bounce and is now giving back some of these gains. Like what we experienced for most of November, most weakness is concentrated in small-caps and growth stocks.

Overall, this is a healthy reaction (that I am salivating at the prospect of taking advantage) within a rally that started last Friday as opposed to prices continuing lower and breaking last Friday’s lows.

Here are some of my reasons for believing this:

• Q4 earnings are off to a very strong start with strong beats and raises in cyclicals sectors like semis and housing.
• The market has digested a much more hawkish Fed and aggressive hiking schedule with only a small drop in stock prices of 5%. To me, this is a bullish sign that earnings growth is strong enough to offset this headwind.
• Q4 seasonals which are even more powerful in the last 2 weeks of the year and in years with the S&P 500 up more than 20%.
• The fund manager dynamic which favors buying into year-end especially if the S&P 500 can make new highs

Given these factors, I ‘m looking to take advantage of inflection points in the market to increase exposure to the best sectors in the market while remaining fully invested.

Top Stocks and Sectors

As noted above, semiconductors and housing have been standouts from multiple perspectives. In Q3, I noticed that they had some of the best earnings reports which was resulting in very attractive valuations.

Further, many companies in the sector had flat prices for much of 2021 which was creating favorable setups in terms of risk/reward. One of our best-performing stocks is a housing supplier and is up more than 80% for us.

Another sector that has caught my eye is industrial metals. This group was slammed during the summer months as the Chinese economy was decelerating, and there were systemic concerns about the Evergrande (EGRNF) situation.

A few months later, the Chinese government just lowered the reserve requirement, and recent import and export data has been at multiyear highs. The Evergrande situation continues to linger, and a default looks likely, but I think any weakness would create a buying opportunity.

Finally, I want to note that the current market setup is quite attractive. The market’s bounce and drop has given us a nice stop-loss that shouldn’t be violated if our thesis is correct. This means we can be comfortably aggressive above these levels.