Equity and other markets review 19.09-23.09
Everyone who was bullish turned bearish. And those who were bearish stayed that way.
General market overview: Rarely does one witness a near 100 handle move in SPX that take less than a minute to develop. Well, 2022 is here to bring you at least one of those. Bad CPI data on Tuesday got everyone (including me) on the wrong side of the market. While everyone was focused on what food and energy are doing for trying to get a feeling on upcoming data, what actually did matter most was inflation in everything else. After being caught wrong-footed, I quickly checked what the current weights for the various categories in CPI are, and was surprised to see that food and energy account for less than 25% of the overall number1. Shelter alone accounts for c. 30%, so its impact is at least not less important and if you add transportation services and medical care (drugs, equipment and services), you quickly up those percentages to a bit less than 50%. What seems obvious in the rearview mirror is that I was not alone in my view, given how that single data point changed sentiment. Since Tuesday, buyers appear to be completely missing. Thus, the SPX finished down c. 5% and had its worst week since the last inflation scare in the beginning of June. The hefty support around 3900 broke on Friday and even if it proves to be a fake one (as of now), I do believe we are headed south and I do not see good support level all the way down to the 3725 -3750 area. Hate to say what I think is the concensus view, but price action and sentiment dictate here, so I try to listen.
Rates tell a similar story. The yield curve lifted up and flattened (except on Friday) with front rates blasting through its recent highs, whereas the 10y, 20y and 30y behaving much more tame. One can feel that there is a fight between buyers and sellers in the long end, where resistance is still being kept despite what happened last week. We have entered a long position in the ETF proxy of 20y rates - TLT, looking for a safe haven bid at a good level. If interested, please make sure to check our Credit weekly review. To be fully honest, last time I had this thesis for a short term trade it did not quite work out but I still believe it a solid one and have given it a second shot.
It does not come as a surprise that the dollar had a decent week too with rates up and the market down. EURUSD is trying its best to hold around parity and by being the most impactful currency within DXY, it does cover how the dollar performed against the other major currencies. All the other big currencies, the JPY, GBP, AUD, CAD made new lows and further cemented the risk-off narrative.
Sector overview: No sector was spared last week. The general risk-off sentiment blew out even those sectors that are believed to be inflation hedges, such as XLE (energy) and XME (metals and mining). What made an impression on me is the force with which VNQ started to sell-off but I admit it could be bias as we have a mid-to-long term bearish view of everything housing related. I am watching the developments in RE related sectors (VNQ, MBB, REM, XHB) closely and we are already short REM. However, following the FedEx news on Friday about the darkening clouds on the global economy, my belief is that few (if any) sectors would be spared if we continue on the same path.
While this is not a sector find, I decided that I must share it here. Do not know whether this is law of attraction but ever since I stumbled upon this chart, silver has been performing much better than gold. I saw it first in a tweet by @paulomacro but it is circling around twitter with the speed of light. Would love to give credit to those who made it, but I do not who they are.
It shows cheapness of silver relative to gold on a huge timeframe. And perhaps this is why the ratio of silver-to-gold has been correcting rather fast the last couple of days, now that people are getting aware of this fact.
I am rather bearish on gold, but after last week’s price action I think the train has left the station. I am left with the option to wait and see how both precious metals are doing, and if they are ready for a bounce, I would just pick silver as my preferred trading vehicle.
Potential trades: As we have firmly reverted back to thinking that inflation is the root of all evil (to put it simply: inflation drives rates, rates drive everything else), I have spent some time researching the last several talks of the guy in charge of fighting it - J. Powell. Interestingly enough, it seems that there is a repeating pattern on FOMC meeting dates, just after the press release. Bear with me and look at the following charts to check whether you too will see it. I will start in chronological order, starting from Nov 2021 to the last meeting in Jul 2022 and will end with his talk on Jackson Hole, although I do not take it into account for the purposes of building the stats around the potential trade.
Do you see it or it is just me? It appears that on each of the last 7 FOMC meetings, the moment J. Powell starts speaking, which is exactly at 2:30pm, the market starts trending. To be fully transparent, Sep 2021 is different with choppy price action but it does not make the recent phenomena less impressive. Let’s put it this way - what is the outcome if one enters at the end of the 30min bar (at 3pm) in the direction of the bar and exits at the session’s close. Here is the summary:
Following this play, one would have had 7 wins out of 7 trades. There are plenty of ways to play this out. One could simply try going long/short futures and wait for the close. However, placing the stop at the low of the 2:30-3:00pm bar would result in a rather poor risk-to-reward if one is not lucky enough. Another play is buying a close to the money (ATM) call/put spread and aim for around 1:1 risk-to-reward. This is also not very impressive but at least you now how much you can lose at any point in time, which is why I would rather choose this one. Of course, one could aim for a run with an OTM option structure to juice things up if he feels lucky or has personally put more weight on the specific narrative during that speech. Sharpen your pencils, because you will get a chance to try it out if you want on Wednesday this week.
Current positions: I have cut all my longs and I am currently short bitcoin (BITO), QQQ, REM and BBBY.
Readers here know we were positioned long going into CPI. After such a reading we did cut all of them (DKS, CLF, ABNB). I even took off the tiny size in the 310-295-280 long put fly in QQQ out of fear we might go past the lower strike. I am thankful we had some good profit to cushion the blow as we were very wrong about the data itself and how the market would react to it.
The following days I was looking for a decent entry to build a swing position in QQQ but the bidding was so appalling that we had to go with very short-term higher delta positions aiming for a breakdown in indices.
We started with a long Sep 19 294 call in QQQ and short underlying on Thursday. We added a short 283 put with the same expiration on Friday as we got the move in the desired direction and wanted to juice the risk-to-reward of the trade.
In a similar fashion, expecting the weakness to translate to crypto and for it to continue its losses, we entered in a long Sep 30 12 call in BITO and short the underlying.
We are also short REM through Oct long put spreads 27-24 and put ratio spreads with the same strikes, given our view that RE in all shapes and forms would suffer with the huge increase in the short term rates. It is at a decent spot for a short technically and was not expensive given the dividend included in the price. The chart below shows what happened to it last time we got the short end jumping crazy (mid June). I am hoping for a round 2 of those panic moments.
Conclusion: It is my belief that all who were bullish turned bearish last week. And those who were bearish stayed that way, meaning that bidders will be hard to find if we stay the course. It was not only the CPI print that made sentiment turn sour but also the warnings coming from FedEx, a barometer of the economy. I am waiting for decent entries to expand my short portfolio.
https://www.bls.gov/cpi/tables/relative-importance/2021.htm