Don't go for the home runs
Equity and other markets overview 19.12-23.12.2022
General overview: Last week was like watching a wild football game in which Team A (bulls) scores first only to be beaten by Team B (guess who) in the last 10 min. Sort of Bayern Munich vs Man Utd (aka the Red Devils) during the Champions League’s Final in 1999. On Tuesday, algos had no mercy bringing indices up 4% pre-market on lower CPI only for the fading galore to occur during the session. It made a really strong impression on me how the news + market reaction to the CPI that day was the exact opposite of what happened at the lows on 13 October, prompting me to post this:
As hinted, I do think the price action screamed that the end of the bear rally has come. Powell’s words and ECB’s Lagarde only affirmed that hopes for a soft landing are premature.
All of this ended with $SPX finishing 2% in red territory for the week. More importantly though, after ECB’s super hawkish stance, the DXY might have finally held ground for a bounce. Rate differentials quickly turned into recession smell that got translated into a weaker euro on Thursday. $DXY is also nicely sitting on the sma50w.
Bonds also look to have stopped at good support levels. If they start climbing again, coupled with a strongER dollar, financial conditions would make it harder for equities in 2023.
With Triple witching now behind our backs, MM’s inventory should be well balanced and no nasty gamma runs are to be expected. Add to this the very seasonal part of the year and the low volumes that are about to come as everyone goes on holiday, I expect a big nothing burger until 2023.
I want to point out that it has been a turbulent year and many people have been caught offside. I strongly believe that one should not try to breakeven, lessen the losses meaningfully or go all in a last attempt to make things better. It happens to everyone, preserve mental and financial capital. You will definitely need those as 2023 will be even more interesting than 2022. The last 2 weeks of the year are not the time for doing homeruns.
Sector overview and potential trades: Clearly, on a down week most sectors did poorly. But some have actually managed to finish the week on green territory and I will focus on those. Despite VNQ being ran over, XHB did extremely well. Following good earnings reaction on LEN, the sector’s behavior is one of the most perplexing out there. I am still wondering how this one managed not to get crushed even harder in 2022, which is precisely why I think it is worth pointing it out.
Other than this, the small biocaps (XBI) is still in this monster consolidation, which I am following closely for a breakout. It finished the week c. 2% up.
Real economy sectors were brought down by force, as suggested in the last week’s substack. Some mean reversion was due.
On the commodities part, oil has bounced off the 70$ lvl with US administration saying it will start filling up the SPR from February onwards.
The jump on the news was not impressive, and I have snipped a couple of comments by an energy CEO on the topic from the weekend article on the topic (source FT) providing the supplier side’s opinion.
The debate is still ongoing and I am following but there is little doubt in me that oil is already pricing a recession, meaning the worst in terms of price action is behind us. Of course, it can go lower, but there is asymmetry here for the longer term. The demand coming from refilling will last long enough, given the historically low inventories that are left.
I have also spent quite some time pondering on two other key topics that are on my mind - expected deterioration in Europe and tax loss selling.
On the first front, following what ECB communicated, there is little to no hope of EU’s economy deteriorating next year. Salvation might come from China given the reopening and the demand increase that is expected with it, but QT and raising rates would be such a headwind that I doubt anyone can put the sunny hat on when speaking about it. I pray for a bounce in DAX so I can short it for the mid term.
I have also noted that EU banks are super strong and have actually faded the ECB comments. Yes, there will be a brief period of getting paid on the short term rates before adjusting the deposit liabilities’ cost, which will provide some decent profit to banks. However, real estate issues are around the corner. Many governments have already enacted measures ranging from capping interest rate on mortgages, allowing earlier repayment without fees to straight out short term moratoriums on payments. All of this will cost the EU banks dearly. What is more, worsening economy is just another blow that is coming to them.
On the second front, tax loss selling, I have come across several US equities that might well be victims of such behavior - RIVN, LCID, RIOT, MARA and others. There is no way to know this for sure. If I am right, those tickers will continue underperforming until year end. The last two of those, RIOT and MARA, are crypto related which fits well with my bearish view on BTC. I just love how everyone suddenly stopped looking at it while it rejected sma50d with force all the while Powell and ECB have clearly expressed hawkishness last week and DXY and bonds posed for a bounce.
Current positions: I am long KRE and short XLF (full position)
Unfortunately, last week IWM vs SPY hit my stop and I had to get rid of it, just when the seasonality is starting its best period. I still believe the trade is valid but I cannot make compromises with my risk management. A stop has to be honored. If you are still not in it, I strongly advise you to give it a close look.
I have entered in a similar small vs large cap trade, albeit expressed only in the banking sector. Long KRE and short XLF got me as the pair has been extremely oversold and is currently at good levels. It has a bit of seasonality in it as well. As I expect no real apocalypse until year end, I thought I have to try it out.
Conclusion: We are entering into the most seasonal period of the year, having dropped quite a lot in the previous sessions. 2023 is to be not less interesting than 2022 and given the little time that we have, I think preserving mental and financial capital is most important. However, I do see some nice setups and if they give me a good price, I will act upon them.
Great post with solid ideas! Thanks for sharing!