Andrew’s Note: Andrew Miller here, managing editor of Market Minute.
Before you read the latest essay from our analyst Clint Brewer, I want to remind you about Jeff’s urgent briefing coming soon.
On October 12, Jeff will make a big announcement in Las Vegas… and what he’ll reveal may seem like blasphemy. He’s identified a rare “12-day window” that could make you “option-like” gains without touching options. It’s the first time Jeff is sharing this unique strategy, but he may never recommend it again.
So, sign up right here for more details on how you can position yourself for the biggest money-making opportunity in 14 years… before it unfolds across the market.
Famously blunt tools.
That’s how Fed Chair Jerome Powell described the Fed’s policy weapons in the fight against inflation… because rate hikes are being felt in the economy via two big avenues.
The most direct impact is how rising interest rates result in higher borrowing costs. Meaning, greater interest payments on debt, and less money falling to the bottom line.
Heavily indebted companies are particularly vulnerable, and you can already see growing signs of financial distress.
For example, the cost of high-yield debt is surging and is at the highest level since the pandemic started.
Take a look at this BofA High Yield Index to see what I mean…
The other impact is more indirect and reflects how the Fed’s monetary policy eventually impacts overall demand and economic growth.
The higher cost of borrowing puts the brakes on corporate spending, and acts as a tax on consumers.
Just think about those higher mortgage payments with the surge in borrowing rates, or the increased cost of building a new factory.
That reduces aggregate demand (a measurement of the total amount of demand for all goods and services produced) in the economy, which is why investors are concerned about the outlook for corporate profits.
Last week, I showed you how leading economic indicators were pointing to slower growth ahead. And now that’s showing up in earnings estimates for next year.
On the chart below, you can see how next year’s earnings per share (EPS) estimates are being revised lower for the S&P 500…
EPS estimates are used to measure profits. A higher EPS indicates greater profits and indicates investors will pay more for stocks.
So, with a combination of rising borrowing costs and falling profit estimates, the Fed’s interest rate hikes are acting like a hammer on the stock market.
Use This Tool to Spot Opportunities
One way to evaluate a company is by analyzing their product line-up, industry environment, or strength of executive leadership.
But I like to break companies down by their quantitative characteristics, or quant factors.
A quant factor is a way to rank a company based on some data point. That could include its stock price momentum, profitability, or a valuation indicator.
Empirical research and backtesting let me know which quant factors can predict stocks that could outperform… or fall behind.
That means factors are a terrific tool for sorting through the universe of stocks and assessing their potential to perform on the things that matter most.
You’re probably already familiar with several quant factors… like focusing on companies with high-quality balance sheets, or companies that trade cheap relative to their earnings.
By using factors, you can quickly evaluate trading opportunities based on hundreds or thousands of data points.
And these factors don’t just pinpoint which stocks could outperform. They also excel at identifying which stocks could underperform… or experience outright declines in their share prices.
That’s why I’m steering clear of companies that rank poorly based on their balance sheet health, and those already seeing a big negative revision in profit forecasts.
Free Trading Resources
Have you checked out Jeff’s free trading resources on his website? It contains a selection of special reports, training videos, and a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out.
Avoid These Stocks…
When I look at those factors combined, my quant rankings show three stocks in the S&P 500 that are most susceptible to these pressures, including:
Royal Caribbean Group (RCL)
I’m avoiding long positions in those stocks and might even evaluate put options to profit from the downside.
Either way, I’m still being tactical in this fast-moving market.
Because even though the S&P 500 has fallen 12% since mid-August, we’re seeing a sharp rebound so far this week.
My colleague Jeff Clark called out the oversold conditions and the stock market’s bounce potential, and just grabbed a triple-digit gain using call options.
That just goes to show that there will continue to be many trading opportunities in this environment, so be sure to check out Jeff’s upcoming market briefing right here.
Analyst, Market Minute
In today’s mailbag, Market Minute reader Randolph thanks Jeff Clark for his trading knowledge…
I’m a new investor into this market of ours, and I appreciate the things that you’ve taught. I’m still trying to understand some of the charts and other definitions within options. I just want to say thank you.
– Randolph K.
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming at [email protected].