Waiting for the extensions

Equity and other markets review 09.01.2023 - 13.01.2023

General market overview: First week of the year saw the market finally breaking out of the tight range that was the mother of all theta killer for more than two weeks, at least partially thanks to the JPM’s fund. Surprisingly, Monday through Thursday was a deja vu of the last days of 2022. Finally, the data on Friday proved as a catalyst to get the market to the upside. I would argue that it was not that much that the equity market wanted to go up rather than the bond one, which was extreme move down across the whole yield curve.

On a weekly basis the 20y rates dropped by 30bps, but that was not the only thing moving in fixed income. The Eurodollar uptick was not less meaningful with Dec 2024 contracts going all the way back to December highs in one bar.

The dollar did get the same memo and quickly gave back a lot of the gained ground from the previous days, which I imagine fooled a handful of people who have long been waiting for a bounce in DXY.

All of the above had to ventilate through the equity market helping SPX finish on a very positive note. Nevertheless, the index now resides between the 50 and 100 day moving averages and right at the solid resistance of 3900.

While the momentum on Friday did provoke FOMO even in yours truly, I managed to stay out of getting long as the train had already left the station. The idea of chasing into resistance after such a day is definitely not my cup of tea, even though I like the idea of breaking out of consolidation on a catalyst followed by such downtick in rates and the dollar. The skies above are murky in terms of technicals, with another heavy hurdle to pass around 4000, where the trend line since 2022 and the sma200 on the daily timeframe reside. On the other hand, Tuesday and Wednesday do have the potential to surprise everyone as we will find ourselves listening to Master Powell and getting the latest CPI data.

So where to now? After missing to get a sexy OTM call spread in QQQ as originally planned of Friday, I am faced with praying for an overblow extension in either direction. In general, with terminal rates still at 5sh %, stocks should not smell anything above 4100 - 4200. Given that nearly all if not all megas are currently at the lows, a push to these levels is definitely within the realistic scenarios we might soon be facing. If that is to happen, I would be more than willing to take a shot on the short side.

Sector overview and potential trades: It comes as no surprise that the almost all sectors had a very strong start of the year so I will just comment on some of the moves that made the most impression on me.

XHB - arguably one of the most bullish charts out there. I have been a long conveyor of the idea that homebuilders are one of the subsectors that will get hit hard the most in a recession scenario. Well, I did see the case that even with a soft landing, if rates are to stay at 5%, home prices are to get a meaningful repricing and with less affordability the business is about to get hit. Cannot say I still do not see the logic in this line of thought but have to say that price action speaks for itself and is yelling at me (and a lot of other folks) that probably we are missing something. The sector was up 5%+ last week and the chart looks fabulous for a long. It is just the fundamentals that keep me away from trying to look for a trade here.

KRE - it is not the first time that the regional banks are mentioned here. Not as a solo play, but rather against the larger financials XLF. I played the oversold ratio on the long side, took some profit and exited the trade feeling something is odd just before it made a new low. At this level I am tempted to initiate a long again. Inversion of the curve is still a pain for both sectors and deal making is not the thing that will make the big banks stand out in 2023 if all things remain equal. Trading revenue will also not be the lifesaving jacked if volatility remains subdued. Still waiting on the sidelines but I cannot say I do not like how oversold the regionals are compared to the big banks. Level on the ratio chart is good too.

XLK, QQQ - Friday’s price action in both long end rates and the Eurodollar futures definitely made me thing of a long in the tech space. I know those are not the names to be long in the big picture of things, but we are now speaking for some swings at good oversold levels with a bit of a tailwind. If Powell and CPI come to push the market higher, I believe 280-290 is a very achievable target.

APE - I am not going to talk to you about the arb trade with AMC. I am just finding myself in the situation where I am fishing for some speculative names that might be lifted along with everything else. Economically, AMC = APE and there has been some interest by the company to seek convertibility of the two tickers all the while APE is trading at 1.36$ and AMC at 3.85$. The company can only issue APE shares, meaning that at some point the APE shareholders (mainly sophisticated investors) will outnumber those in AMC (mainly retail) and thus the convertibility proposal shall be passed. Some people have also gone through the numbers and believe there are more APE shares than AMC as of now, but have not checked it myself yet. So, when having to pick one of the two in this scenario, I would rather choose APE instead of AMC to express a very speculative trade. The chart also looks much better.

PFE - Beside a very nicely looking chart for a long trade, PFE had big news on Friday. China appears to be in talks with Pfizer to license manufacturing and distribution of a generic Covid-10 antiviral drug in China. Not really in the know of things, but if there are no IP hurdles, it sounds insanely bullish to be. Traded the momentum on the long side but the fact that there was no good profit cushion as of the close (merely 0,5% from my entry) I decided not to take the risk of it being a false rumor. Despite this, I believe the setup is solid and the risk to reward if this is real is skewed to the upside.

Last but not least, I am following closely a handful of overextended tickers to get some short scalps on. Look at BA, MAT, DAX, FXI if you are interested.

Current positions: I am having little to no exposure at the moment. I am short just half of my usual risk in AGNC with a 8$ put expiring in March. I was asked to give some more backing of the trade so I hope the following would suffice. When I entered the trade (just before NY), AGNC appeared to be trading much higher relative to other names in the space (NYMT, PMT, CIM, NLY, REM) and near very good technical levels for me to bet against it. The extrinsic value was really small, around 30c so the trade was very cheap to begin with. In general, AGNC has a very tiny ATR but in a crash like scenario, something that happened in late September, things get really ugly. In that sense, there is a lot of convexity to the trade and to me it looks like a great way to hedge tail risk in credit spreads as well as outside moves in both short and long term rates. As of now, nothing makes me want to add or cut off the exposure. I have my stop a bit above the sma200d and will honor it if proven wrong, but to be honest, I still like the trade and the idea behind it.

Conclusion: Given the move in rates, the uptick in Eurodollar futures and the levels the indices are trading at I believe there is a potential for SPX to reach 4100-4200 if Powell and CPI serve as drivers for bidding. I would love to wait and trade over and under extensions in individual names and indices and would rather not chose a side as of now. I am sure the market will provide us with plenty of opportunities in 2023.