The Most Important Chart for the Stock Market Today

One more thing about earnings season... The most important chart for the stock market today... Wall Street analysts are slow to react to everything... Ignorance is not bliss... Why you shouldn't bet on an oil bust... Mailbag: Getting to the bottom of inflation data...

Before earnings season really gets going later this week...

I (Corey McLaughlin) have one more thing to point out that I neglected yesterday...

I meant to include this chart in yesterday's Digest when I talked about earnings season... Our colleague and Stansberry's Credit Opportunities editor Mike DiBiase reminded me of it.

It shows Wall Street analysts' consensus earnings per share ("EPS") estimates for the benchmark S&P 500 Index this year and the next two years. And according to Mike, "It's the most important chart for the stock market today"...

Inflation remains at record highs (more on that in today's mailbag). There's a growing risk of recession. We've been talking about these impacts for the past six months. And yet... Wall Street still sees only good times ahead.

Based on this consensus estimate, investors expect the S&P 500's EPS to increase 15% this year from 2021, then another 9% in 2023 and 2024.

The markets – and life – can often be a game of managing expectations...

In this case, optimistic Wall Street expectations for America's biggest businesses mean there's plenty of room for disappointment. We could start to see that shortly as most of the S&P 500 companies report their second-quarter financials over the next several weeks.

As Mike wrote in the June 30 Digest...

Clearly, the market hasn't priced in a recession yet, much less stagflation [slower growth paired with high inflation].

I believe we'll start to see companies guiding down their earnings as we get into the heart of the next quarterly earnings season, which begins in July.

Yes, the fundamentals. Remember those? The market is valued based on a multiple of its expected earnings. When those earnings don't live up to expectations, stocks fall.

And it gets worse... As Mike said, these pessimistic changes to earnings are also likely to bring down the market's valuation multiple, meaning the prices of shares relative to companies' earnings. In other words, both the market's earnings and its valuation multiple are likely to fall in the coming weeks.

People pay more attention to the fundamentals in a bear market when money gets tight...

We got into more detail about this back in May, when our colleague and Stansberry NewsWire editor C. Scott Garliss explained that stocks – despite selling off through the first few months of the year – wouldn't look "cheap" for very long.

Not much has changed since then... Wall Street's forward 12-month price-to-earnings (P/E) multiple sits near 16.7 times analyst estimates. (It was 16.8 in May, after first-quarter earnings season ended.)

That's a hair below the 10-year average. And it's not far above the 25-year average. But as Scott warned then, be careful listening to anyone who was saying "stocks are cheap" and that it was time to buy.

Trouble ahead, trouble behind...

As we quoted Scott in the May 23 Digest...

The thing you need to remember about Wall Street analysts... They're slow to react to everything.

Scott worked for 20 years on Wall Street before joining Stansberry Research. He said when analysts cut their earnings estimates later this year – as he expected in May that they would during second-quarter earnings season (now here) – P/E multiples will explode.

In turn, that will make the stock market look expensive again...

And when that happens...

It will set off another round of selling to drive the multiple back to a "fair value level," Scott says.

In other words, investors will be willing to pay less if companies post underwhelming second-quarter results and cut forward guidance... because expectations are still high.

We're seeing this play out already...

Yesterday, investment bank UBS cut its earnings forecasts and year-end price target for the S&P 500 to 4,150 – down from 4,850 – because of concerns about slowing economic growth and rising costs. Other firms and pro analysts have also taken similar actions lately.

You might be wondering why it took so long. Some Wall Street analysts and institutional investors have already started to price in bad times, but many often act as if they're the last to know... then only pull the trigger on valuation decisions when they can argue them with little doubt.

That's when casual traders get in on the act, thinking a company is doomed or overestimating its promise based on one quarter's earnings report. So that's why you see headlines like "Netflix shares fall 20% on disappointing earnings."

Conversely, companies could beat analyst estimates and raise guidance, giving their shares a boost. We've seen that in a few instances already from the handful of S&P 500 companies that have already reported second-quarter results...

Yesterday, I mentioned Levi Strauss (LEVI), the jeans company. Despite inflation and supply-chain pressures, the company beat second-quarter expectations, raised its dividend, and increased its projected net-revenue growth for the year from 11% to 13%. Its shares popped 4% on the news.

Now, this isn't a buy recommendation for Levi Strauss, but an anecdote for informational purposes about earnings estimates. It's also an example of the type of business – one that makes or sells the "always needed" kind of things, like jeans – that you want to consider owning to help your portfolio weather tough times, like a recession.

Ignorance is not bliss...

Different folks may have different opinions on whether the market has lower to go or how much. The point is, given Wall Street is so overly optimistic today, it's not time to get bullish on U.S. stocks just yet. As Mike told us today...

Clearly Wall Street is ignoring the possibility (I'd say certainty) of a recession. I don't know how anyone can say we are near a bottom in the stock market looking at these rosy estimates.

With inflation and interest rates soaring, Mike said, the chance of companies achieving these optimistic estimates is next to zero. In other words, the risk-reward is simply not skewed in buyers' favor today.

Moving on, some notes about oil...

I've mentioned a few times lately that commodities have sold off big-time over the past month or so. That includes oil, the biggest commodity of them all...

Oil peaked at $122 per barrel on June 8. Today, a barrel of West Texas Intermediate ("WTI") – the U.S. benchmark – traded around $97. That's a 20% drop. You've probably noticed gas prices going down a bit at your local station, too.

But as our colleague Brett Eversole wrote in today's free DailyWealth newsletter, folks betting on prices to continue falling in the short term might be making the wrong decision...

As Brett explains, according to the latest Commitment of Traders ("COT") report for oil, futures traders – a combination of small-time speculators and Wall Street pros – are overwhelmingly bearish. This extreme is an indicator that the recent sell-off might be overdone.

COT reports – which are published in various industries – detail how many long and short positions are open in the market. As Brett explained today...

This weekly report shows what futures traders are doing with their money. And it has a history of being a strong contrarian indicator.

The COT report shows massive numbers of folks making bets against oil. Heck, traders haven't been this bearish since early 2019. Take a look...

This extreme pessimism isn't what we would expect right now. But regardless, it tells us oil prices can continue to rally.

This might sound counterintuitive, but consider the last time futures traders were this bearish on oil...

As Brett wrote, in 2019, oil had just finished a crash, dropping roughly 40% in only a couple months. Futures bets hit a multiyear low... and oil rallied from there. From where the COT hit bottom, it jumped more than 20% in just two months.

This is all to say, be careful betting on an oil bust...

Long-term supply and demand trends remain bullish for oil prices, as our colleague Steve Sjuggerud wrote in the May issue of True Wealth Systems, when oil was on the rise...

The knee-jerk reaction of most investors is to believe this rally can't continue. And you might think a sharp correction will follow. Again, I hear you. But that's not the smart bet to make today.

We're likely nowhere near a peak. Not even close.

Now, let me be clear... I'm not going to predict $200 oil. But we could very well see oil prices stay above $100 for a while – and even go higher.

There are two reasons why oil and gas prices can go even higher from here, Steve said...

The first reason is painfully simple: Companies aren't pumping enough oil out of the ground to keep up with today's demand.

We can see this through the U.S. oil-rig count. It measures how many rigs are actively pulling oil out of the ground.

The latest Baker Hughes Rig Count report, published on Friday, shows the U.S. has 752 active rigs. That's about 200 more than in May, but still below the previous high of around 900 in late 2018.

Hundreds of rigs shut down during the great oil bust of 2020 when the pandemic and ensuing lockdowns brought oil demand to a halt, backed up pipelines, and briefly caused the price of oil to go negative. More from Steve...

Oil prices were way below the "breakeven" price at which oil companies can start to turn a profit. So instead of running at a loss, it made more sense to close up shop. That year, the active rig count fell below 200 for the first time in at least a decade.

We've improved from that extreme low today. But the number of active rigs remains below average... And it's still well below 2018 highs.

The second reason, Steve said in his May issue of True Wealth Systems, was the bearish sentiment around futures traders about the price of oil... That trend is still in place, as Brett wrote in today's DailyWealth...

Betting that oil prices will keep falling is the crowded trade today... And that's why the recent sell-off isn't likely to continue.

Wrapping this up, you might sense a theme today... We're zigging when others are zagging.

When it comes to earnings, several of our editors see that Wall Street is too optimistic... And with oil, Steve and his team believe folks are too bearish and suggest things will go the opposite direction.

'You Ain't Seen Nothing Yet'

Doug Casey, the founder of Casey Research and a bestselling author, joins our colleague Dan Ferris on the latest episode of the Stansberry Investor Hour... And Doug doesn't mince words...

He says American life is increasingly revolving around the government, and that's putting people at odds with each other. "The entire country has been greatly over-financialized," he says. "It's all going to come crashing down."

Click here to listen to this episode right now. And to catch more videos and podcasts from the Stansberry Research team, be sure to visit the "media" page of StansberryResearch.com anytime.

New 52-week highs (as of 7/11/22): None.

In today's mailbag, we respond to a comment about inflation data stemming from yesterday's Digest... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"I always assumed Stansberry's staff were financially pretty saavy, but when you guys continue to base your inflation data on the CPI, WHICH DOESN'T EVEN TAKE FOOD OR FUEL INTO ACCOUNT, it leads me to believe that there might be a possibility you all have a government job as a sideline!

"Don't be afraid to tell us the truth, we're big boys that go to the grocery store with our maxed out credit cards, and then go get a half tank of gas because it's not near as stressful as a full tank." – Paid-up subscriber Don R.

Corey McLaughlin comment: Don, I appreciate the note. I know the "official" inflation numbers strike a lot of people (including me) the wrong way – as in "I'm sure paying more than 8.6% more for things than I did last year" – so I get where you are coming from.

This is why I try to go out of my way to qualify the government's various inflation measures whenever we mention them... and say that inflation hits everyday people quite a bit different than the official statistics say.

Here's how I put it yesterday...

I will not argue with anyone who wants to debate the accuracy of these numbers (and whether they really reflect real-world inflation). But looking at the same set of data each month at least can give us a good directional view of a trend – in this case, inflation.

And I've also even written pretty much exactly what you just did before, such as this criticism of government numbers that conveniently don't consider food and energy prices. It's dumb, in my opinion.

That said, the Consumer Price Index ("CPI") actually does include food and fuel in its measurements, though it's not the primary focus. Housing (42.3%), transportation (18.2%), and food and beverages (14.3%) are the three key components.

Yesterday, our NewsWire team published a great look at the CPI and why we might want to expect the June update – due tomorrow morning – to surprise some people.

But what you're talking about is "core PCE," or the core Personal Consumption Expenditures measure. It just so happens to be the Federal Reserve's preferred inflation gauge... and it excludes food and energy.

The Fed's line is that those sectors are so volatile, including them wouldn't let it accurately measure inflation. Of course, not counting food and energy prices in today's world – or anytime – doesn't do anyone any good when food and energy prices are skyrocketing... leading to a cascade of effects on the economy...

But the folks who control a nearly $9 trillion balance sheet and control how much interest you pay on your mortgage think this is correct. So even though it makes for a huge disconnect in policy – since CPI is actually used by other government agencies, like to determine the Social Security cost-of-living increase – that's what we have to work with.

Here's the important part...

Core PCE – which, again, doesn't include food or energy – is the number the Fed is referring to for its long-term 2% annualized inflation target. The most recent core PCE reading checks in at 4.7% for May, down from 4.9% in April, and 5.2% in March.

I'm not saying it's right. But in the Fed's wood-paneled conference rooms and economist bubble-land, this is what they're looking at – not the total cost of your grocery or gas bill compared to last year.

Recently, Fed Chair Jerome Powell has said the central bank is considering food and energy prices more than they have in the past. I'm skeptical. He has said so much garbage over the last two years, it's useful to go with the opposite of what the guy says.

Let's say the CPI remains higher than usual, but the economy has fallen into recession and core PCE increases get closer to 3% – which could happen toward the end of this year or next year. In this case, I see the Fed saying, "Inflation has gone down enough, let's fire up the stimulus again to get us out of this recession."

And then on we go with our problems...

The point is, what the Fed does and what numbers it looks at – not the ones we might want them to look at – matter for stock prices and more...

I'd love for the Fed's economists to base monetary policy on my personal budget, but that's not how they roll. So that's why we'll continue to cite weird acronyms like CPI and PCE and refer to them with skeptical quotes as "official" every time we do...

But we also know inflation is hurting a lot of people a lot more than 8.6%. I don't want you or anyone else to think that we don't understand that.

If you calculate CPI the way the government did before 1980, as John Williams does on his ShadowStats website, it shows inflation above 15%.

Hope that clears things up.

All the best,

Corey McLaughlin
Baltimore, Maryland
July 12, 2022