Trades before the fireworks

Equity and Credit markets ideas going into 2023

EQUITY MARKETS

I will keep it brief today and cut the fat from this week’s newsletter. I will do so not because I don’t see the value in going through the usual triangle SPX - TLT - USD and the dark paths it leads us to, but because it is Christmas and 1) it is generally a good time to get a break; 2) nothing really happens to the market besides some window dressing.

The things I want to share today have a diverse time horizon to play out, some are micro and others are macro. I have always enjoyed having an opinion on topics that I know little about and frankly, my style of trading does not require much but a thesis that could be laid out in two scentences as long as I know where my stop is. All the ideas below fall within those three major categories 1) window dressing, 2) tax loss selling and 3) macro/fundamental views. Naturally, the former two categories require a shorter timeframe as they are calendar based. The latter, I tend to use more as a general bias as we get into 2023. All in all, most of what we do is art and not science, thus there is no way I could know with certainty if I am right allocating tickers/ideas into the different categories. As traders, we live and breathe on partial information. For this reason and in an effort to increase the odds of positive expected value when trading, I love stacking arguments to get into a trade to build conviction. Without further ado, here are the categories and the corresponding ideas.

Window dressing - the phenomenon of bidding up your profitable (but not only) positions on thin liquidity near year end to make your reporting numbers look nicer. It is usually harder to find those out when the market has marched up and to the right. However, this year has been a bit different. So, what has gone up? Energy. XLE (and other names) seems to be well positioned technically for some bidding into year end, after spending some time above the sma100d.

Other related sectors such as AMLP, XOP, XES will also do the job, having been through a short consolidation recently. XES has even been showing relative strength, hovering around this year’s highs.

What I like here, is that oil has a lot of reasons to be strong going forward in 2023. Yes, it is mainly around the reopening narrative in China, but hate it or love it, it does make sense that after 2 years of pandemic and restrictive policies there will be pent-up demand.

We have a XLE call spread Jan 6 85-88$ on. Unfortunately, it bears only half size.

Tax-loss selling - the concept of getting your losses realized in order to decrease any taxable profits you may have. This one is not less tricky to notice but there are some pockets where I believe it is more evident. The problem here is that one does not know when the selling will stop. On the other hand, it can be played both on the short side before the selling stops or on the long side as those names pop up once price insensitive selling ends. Notice how LCID has been trading lately.

Every single attempt for it to come up has been met with supply. One can argue that TSLA looks no different and I have to agree that it certainly does not help to have the sector suck so much. But hey, I do think it there is some tax selling in TSLA too. Other tickers that I think are good candidates are the cruise names RCL, CCL, ABNB, ARKK and many others. Unfortunately, 2023 does not look like too bright for those, so if you happen to get long, I suggest you hold those tickers lightly.

I know all eyes are on TSLA going to 0 with the mess around Elon Musk. I do not normally like buying on a red bar looking like the wheels are about to come off but now that the sky is so dark and the stock so heavily destroyed, I had to give it a try.

I got a Jan 6 145 -155 call spread. Just a teaser for those that might like it - have a look at the open interest on 140 Jan 6 calls. I might get shaken out as there might be 2-3 days until the selling come to an end.

Macro - doing macro trades is a bet on the effect economic fundamentals have on the markets. I am as farther away from a macro trader as one can be. So is my timeframe and risk management. But I often have a bias that has a macro framework/ fundamental view as a backbone.

In last week’s piece I mentioned that following Lagarde’s comments I think 2023 will be tough for Europe. Yes, banks respond well initially to hikes and they managed surviving with negative interest rates, so having now positive rates should be a walk in the park for them. But as everything else suffers, so will they. Especially, if they are used as a piggy bank or scapegoats by governments, which I believe is highly likely. SX7E is having a blast and not shorting it for now. I would rather concentrate on the DAX itself. Europe’s best case is no war and, for some reason, no recession. But Europe has had a much more traumatic experience with inflation in the past and is currently so much behind the curve in fighting it that I find it hard to see monetary policy not being a headwind for financial assets. Worst case is war, recession AND tightening.

Whichever way I spin it, I just see DAX a great short. Still waiting on my levels and time to come, but I guess it will be sooner rather than later.

These are my thoughts on the equity side that I wanted to share. We are still in the KRE / XLF mean reversion ratio trade. Not trying to jinx it, but so far so good.

CREDIT MARKETS

The story of the week was certainly European rates. Lagarde’s set the hawkish tone and the markets listened. The EU terminal rate jumped from 2.8%ish to 3.5%ish in the span of 5-6 trading days.

As a result German yields are currently testing their 2022 highs. New highs are inevitable given the higher terminal rate. Question is not IF but when that happens.

What I see as a trade opportunity is dictated by the lack of activity in the cash fixed income markets. Most traders and dealers already wrapped up the year and are not present in the market.

This creates quite the discrepancy as government bonds are dropping while cash bonds are not following through, at least not to the extend they are supposed to thus leading to further tightening of credit spreads.

As I am of the view that 2023 will yet again be volatile I think trading widening credit spreads in EUR debt will be a good bet.

One such example might be the REPHUN 1.5% 2050s.

G-spread wise it is in an aggressive tightening spiral which I think is unwarranted. It is trading below the 2022 g-spread lows of 240ish. Quite contradictory given the higher terminal rate.

I intend to position myself in the last 2 days in this trade and other similar trades. I am not sure how long can this tightening continue but from a fundamental perspective I cannot find a reason for it to sustain.

Conclusion: We have a bit left before the turn of the year. While everyone is busy drinking, some opportunities into tax-loss selling, window dressing and credit spreads have caught our eyes.