How Now?

How Now?

Quite the rally over the last two weeks. Where to from here? As I’ve been saying for a while, in the short term, that’s a tough question, but in the long term it seems pretty easy. Fundamentally, this is a bear market bounce, the question is how much longer and higher it can go, and what assets we’d want to hold in these conditions.

Institutions have been selling to retail, as the COT report showed institutions sold off a great deal of SPX futures while selling their puts, instead of reloading protection. Retail is going back to YOLOing short-dated tech calls like TSLA, AMC, GME, and NVDA. Traditionally, when that call flow stops, the stock drops. Can this behavior continue, or something else take its place? Of course. I would point out, however, that we’re around the call wall of 4500, so the easy money (if you can call it that) seems to have been made. VIX is down to 21, and while it could go lower, considering how much chaos is going on right now, there’s probably a limit to how much more comfortable stocks can get.

With those puts gone, arguably stocks aren’t operating with much of a net. According to SpotGamma, if the S&P traded back down to 4475, selling could accelerate. I’d also add the Fed is trying to actively tighten monetary policy, and stocks soaring is the opposite outcome.

Longer-term, I think we’re just marking time until we see the many, real problems assert themselves. We’re already seeing growth slow, but it just hasn’t been obvious enough to be viewed as a problem. Growth for the quarter is tracking poorly, earnings estimates are down, inflation is killing consumer confidence, and so on.

These problems aren’t getting better. As Cross Border Capital notes, rising rates, a flat yield curve, and the short end quickly pricing in a great deal of hikes makes financing and refinancing very difficult. We’ve had decades worth of pretty easy financing, and that’s going away. Falling liquidity is only going to make this tougher. Should I mention the market currently expects a 50bps rate hike in early May and presumed balance sheet runoff start? How will that go?

So, what do you own? Short term, I have to say this is a weird rally, even for a bear market. Yes, ARKK did go up something like 27% from the bottom, but they’re still down on the week and the last month. In the meantime, utilities not only are up for the last week and month, but also hit all-time highs. Not your traditional risk-on action.

I think it’s pretty hard to say what does well over the next two months or so. It seems a lot of institutions are de-risking into problems, which makes sense to me. Ultimately, you want to have a plan and stick with it. For my part, I’m focusing on owning assets that will do well when people realize growth and earnings estimates are too optimistic. I may be too early, but I’m potentially getting good prices and should be well set-up for the back half of the year. We’ve had a number of short, painful (for me) rallies over the last several months, but none have really had legs. We haven’t had any data come out yet to make this one look any different.

Maybe we still could, though. The Ukraine issue could be at least moderated somewhat. China could financially stimulate their troubled economy. Positive things could happen, and if it looks like we’re getting close to something actually happening, we’ll look for opportunities. Right now, though, after a big rally and some risk-on behavior, doesn’t seem like a great time to add risk.

As Goldman Sachs says, the market is currently 33% above pre-Covid highs. Was this because things got so much better in the pandemic, or was it due to the now-fading torrent of liquidity? It sure seems like some people are eager to relive the diamond-hands behavior of the past, but instead of a firehose of liquidity, we have a draining pool.

The only other thing I’d say is if the market does keep going up, eventually we do have to take action. For my part, low volatility broadly continues to outpace high beta, so I’d look for individual quality, safe names to invest in. For now, though, I wouldn’t be chasing anything.