Up but don't forget to take profits

Equity and other markets review 24.10-29.10.2022

General market overview: Last week was somewhat of a continuation of the huge and weird bid that happened on 13 Oct after the last CPI report. As a trader, I believe that one of the most important signals the market gives at turning points is contrarian price action on good/bad news. And this is exactly what happened that day, leaving everyone scratching their heads and looking for arguments why the market did this and that. To me, knowing is important, but not existential. Price action is the ultimate ‘source’ of information. Or maybe such bad CPI meeting such good bid was a one-off thing in the weird 2022, where nothing (excl, energy) has worked. But last week there was a similar tell. The long end of the US market started to look like we are about to experience as a BOE moment.

It felt like the wheels are about to come off as the 20y and especially the 30y broke the upper range of their channels and got to the volatility expansions stage (which usually comes at the end of a trend or at least marks a short term top). Yet, equity indices were as cool as ice, exacerbating the feeling of ‘illogical price action’ that had started the week before. Now, if it happened once on 13 Oct when CPI came out and you think it is a one-off phenomenon that is fine. But if market’s behavior continues doing what everyone thinks it should be doing, then you should pause and reevaluate. Last week I had no idea if the market will follow long-end bonds into the abyss but I had seen the break of logic the week before, so I made sure not to look at the situation the way I had been doing the past 10 months.

Then Friday came and all planets aligned for a move up, with WSJ’s whisperer Timiraos being the last person signaling that FED is looking to decrease the pace of hikes. Rate came down across the curve, the dollar (DXY) rejected again the 114 lvl and equities finally rallied as there was nothing to hold them back.

So where do we go from now? This week is very important, as we are this stage of the earnings season when the bulk of the companies (in terms of market cap) in SPX reports.

I have no clue what the numbers will be. I had previously stated in my reviews that my belief is expectations for this season are worse than what would actually come out and there has been plenty of post announcement bidding. And combining that with price action, seasonal and statistical characteristics of the current period and some steam coming off the bond market, I assume the short/midterm direction is to the upside.

However, I do believe we have capped potential, and I am trying to stay realistic about what the market could give me in a world with short term rates of 4.65% (taking US01Y for reference).

Taking out 3800 lvl seems likely probably where FOMO/short covering would kick in. But around 3900-3950 lies first proper resistance of key levels and technical moving averages. Bear market rallies are much more violent than this and I totally understand that it could go higher (or lower if I am wrong). I am saying this just to remind you that I am not fishing for ‘the bottom’ and looking for a new ATH. After all, I am a swing trader and we are in a bear market so I keep myself away from daydreaming and try to look realistically at the current market. So do not forget to take profits along the way.

Sector overview: On such weeks, every sector does well. So I will just briefly give some color. Obviously, the energy space is doing spectacularly well, especially given where oil is. XLE, XES broke recent highs and with inflation still up there is no reason why they would not be liked by investors. Yes, those are cyclical sectors and earnings are very vulnerable to recessions, but with the supply side being so distorted the 2023 view gets murkier and hard to tell. So I leave price action to guide me here and it looks very bullish. I find it hard to get long as there is so much consensus for being long and I always feel late to the party.

The other sector that I put in the ‘anti-inflation’ bracket is XME. Mining and metals had a beautiful breakout above sma50 and sma100 on the daily after recent consolidation. And price action coming from steel companies is mind blowing. AA had a range of -10% to +10% after it reported earnings and peers did well too. Copper is doing nice, coal has continues to be attractive due to Europe energy problems, etc. Therefore, I think it deserves to be on everyone’s watch list.

On the other hand, there are those sectors that I assume would be much less attractive going forward. Last Wednesday we got housing and mortgage data which were bad and served as a catalyst for XHB and VNQ to trade really poorly. I use sectors with fundamental weakness when I look for hedges to my portfolio but only when price confirms this fundamentals.

However, short sellers beware, as not long after this data, The Economist came up with this cover:

Potential trades and current portfolio: I will combine those sections today, as I believe entries here are still decent and I like them a lot. Of course, never forget to mind your own risk and do your due diligence, knowing I do flip my views often.

Long ABNB - I like how strong the travel sector is fundamentally, despite having headwinds from high energy prices and a tight labour market (e.g. no pilots for airplanes). Comments coming from CEOs of high demands for air travel are coupled with nice price action from UAL, DAL, AAL. ABNB is no different. Currently sits on a sma50 and has decent bidding to it. I have played it with a Nov 115 - 125 call spread but will probably not risk going through the earnings data due on Nov 1.

IWM/SPY - I continue to be long IWM vs SPY through futures but actively looking for good levels to tilt it long as they are now balanced on a notional basis. I am a bit unsure whether earnings will do good to the trade, as large caps have the strongest pricing power due to monopolistic features which also makes me want to cover some of the short ES exposure.

Long EWW half risk - I have been waiting for a nice moment to play a short dollar trade through a proxy. DXY seems to be topping out and rates on Friday gave me further conviction to go out and look for a decent entry. I have been waiting long to get some EM exposure and my two favourites have always been EWW and EWZ. First has this nice ‘end-of-globalization’ feature which would make it benefit as it will likely be a manufacturing hub for the US and the second one is has its monetary policy in line and vast resources to attract anti-inflationary flows. I like them both, but EWZ has elections coming out soon and chose not to get involved in this idiosyncrasy. EWW has also had a nice consolidation and broke resistance at $46 on Friday, making me want it even more. I am long Nov $48 calls.

Long DE half risk - This one I picked to diversify the sectors a bit. When I am trying to get long, I try to bid 2-3 individual stocks which show strong relative performance in sectors I like. Here, DE has been chewing the market uncertainty rather well, and XLI is nicely above its moving averages 200 and 50 on a weekly and monthly basis, respectively. XLI has also been making higher lows since Oct. Playing this one with a Nov 18 call spread 390 - 400.

Short XHB - I entered short on Thursday through a long put spread $55-$50 for Nov. I liked how the price responded to the bad news coming out. Fundamentally, I believe home builders would do badly, as they are now finishing their pipeline with rates much higher vs the time they initiated those projects. As rates have made mortgage financing much less attractive/affordable, not only inventory problems would come up but also future demand is expected to decrease even further.

Conclusion: Market has acted ‘illogical’ during the last week and a half, meaning something is changing. I am positioned net long, but trying to play the sector/stock picking game as the general market upside potential is limited and road ahead is far from clear.