Do not get too HYPED

Equity and other markets review 14.11-18.11.2022

General overview: Euphoric. Buy (what is left) of the dip. Fear of missing out. What followed the CPI print on Thursday could well be called melt-up. The numbers looked good, but given how the market responded to the BAD numbers on Oct 13 earlier this year, what could have been expected from the market to do this time? To simplify it even further, let us say that the CPI numbers could fall into these five categories - very bad, bad, ok, good and very good. We allocate CPI expectations into the OK (median/average) category while every other gets an equal probability for the actual CPI to fall into. Now, what would one assume the market would do, if we look at it through the lenses of Oct 13 and assign a bullish reaction to everything except ‘very bad’?

All of this is to say that I am not (nor should you) be surprised by the direction of the reaction. Market has been subtly saying it wants to go higher. However, I am a surprised by the magnitude of the reaction. One has to go really far to check the last time SPX did 5%+ in a day, which near the Covid lows in 2020. I realize that the FED now has a justification to reduce the pace of hikes meaningfully and will most likely do so, but the terminal rate did not move that much and is still below where it was at the end of October.

What has actually benefited the market more is the big break in trend of the dollar, which caught a lot of people off-guard (hopefully, not our readers) and the move in rates, which at least on Friday behaved calmly.

I find it interesting that the soft landing narrative is what the crowd now preaches yet the growth prospects are not getting better, judging by retrace of the long end rate.

Last retracement between Jun and August was twice as big from high to low in the 20y than the one we are currently experiencing and was accompanied by an 18.5% rally in SPX. This time, however, SPX has already moved up by 14.5% since the lows on Oct 13. It is a simplistic view, but to me it says that we have advanced a lot from the lows.

I am much more inclined to fade this rally near the 4100 level than to chase it here and advise everyone not to get too hyped about the upside potential. Keep in mind that those rallies are often face ripping and go farther than usual. Be patient and know your risk.

Sector overview and potential trades: After such a week it is no wonder that most sectors got bid. Post CPI on Thursday it was obvious that the homebuilders, which are very rates reliant, got a monster bid and a now above the sma 200d. Nevertheless, there is still the fundamental reasoning that house prices are expensive given where mortgage rates are and buyers are yet to show up. I believe lack of strength here should continue but I am leaving this one aside until technicals confirm my bearish bias.

Another observation was the obvious switch from defensive sectors (utilities, healthcare, consumer staples) to more offensive ones such as semis and other cyclicals.

Utilities in particular are now at a good spot for a tactical short, showing relative weakness for some time and allowing one to place a tight stop above technical levels.

It would be an incomplete overview of what is going on if I do not mention the developments in precious metals. Gold has been ripping higher with an astonishing 5.2% move last week.

While lower rates expectations, cheaper dollar and a potential for a recession in 2023 are definitely bullish for gold, I noted that silver has not played along that well and is currently stalling at the sma200 on the daily timeframe under a key 22$ level. For those that believe that precious metals should have no place here with terminal rate at 5%, I believe this is a good spot for a short on a close below the moving average.

Current positions: I am long EWZ (2/3 position), SPX (1/3 position)

I am been long EWZ for some time now. For those who are interested why I am long, you can read more here. I am not too happy with how price action has evolved and I took 1/3 off as a sacrifice to the market gods. However, I still like the idea behind it.

I am also long SPX call flies 3950 - 4100 - 4250 expiring on Nov 30. I got them in the beginning of last week when I saw someone was bidding heavily at 370 and 376 on SPY for two days in a row, despite the index being at a key resistance level near the sma50 on the daily timeframe. This got me bullish with the idea to buy a short term out of the money fly and hopefully sit on some gains right before CPI. Unfortunately, FTX developments were not in my plans and on Wednesday at the close the index was looking rather bearish technically. Therefore, I reduced the position by 2/3.

Conclusion:

Bullish developments have been expected as the market appeared to want to go higher even before it received good news. However, price action post CPI has gotten the indices to levels where chasing makes no sense. What is more, terminal rate is still high, long-end rates have not backed an equity move from the lows of such proportion and the dollar has already been sold off heavily.

I believe that while such face ripping rallies go further than one thinks, best action here is to look for a swing to the downside, shorting ideally near 4100. This is not the moment to get hyped for the upside.