Here's why the stock market hasn't bottom

Rules are there to be broken. Anarchists have a standard mantra that may be true. Such thinking can be dangerously dismissive for traders.

The star analyst describes how one rule with a perfect track record says the market hasn't bottomed, as well as the latest note from Bank of America spokesman Savita Subramanian. Subramanian, head of the U.S. equity and quantitative strategy, says only 30% of the conditions required for a market bottom are currently triggered by the latest rebound that has taken the S&P 500 SPX, up 16.6% from its mid-June low. At least 80% of the conditions must be registered before the all-clear can be called.

One of these signposts is the Rule of 20. The sum of consumer price inflation and market trailing price-to- earnings ratio is lower than 20 when the market hits its trough.

The market P E is currently 20 and the CPI is 8.5%, according to Surbramanian notes. She says that earnings surprise of 50% would be required to meet the Rule of 20, while consensus is forecasting an aggressive and unachievable 8% growth rate in 2023, despite inflation falling to 0% or the S&P 500 falling to 2500.

BofA believes that stocks are not sufficiently cheap because the market is underestimating the chances of a contracting economy.

A 20% chance of a recession is now priced in versus 36% in June. In March, the stocks had a 75% chance of a recession. Even on Enterprise Value to Sales, where sales should be elevated by the tailwind of 9% CPI, the market multiple is excessively elevated 40% relative to history, possibly because real sales growth ex-Energy is essentially flat. Other signs that must be triggered to confirm a bottom, but are currently not include: the Fed cutting rates, a 50 basis point or more decline in the 2 year Treasury yield TMUBMUSD 02 Y, a rising unemployment rate versus the 12 month low, and a sell-side indicator buy signal.

Signals that are currently giving the green light to bulls include: Improving PMIs and more bears than bulls.

Subramanian favors the energy and industrial sectors, and suggests selling consumer-focused stocks.

Industrials could be lifted by strong capex, grew 19% YoY in 2Q and with companies still higher on capex during the second quarter earnings season. She writes that Capex may be more of a necessity in the wake of a tight labor market warranting automation and de-globalization, and should hold up better than in previous recessions.

The S&P 500 has dropped 10% this year. The Dow Jones Industrial Average DJIA has declined by 6%, while the Nasdaq Composite COMP has lost 17%.