Mixed feelings

Well, the markets have staged quite a strong rally so far since my last post and is knocking on the door of all time highs once again. The S&P is actually already there. This week we have FANG earnings on deck and it's happening at a time where the market is ST overbought. It's an interesting junction because although we are ST overbought I get the sense that there are trapped bears out there who shorted the bounce in the market mid October. Why? Because I myself was tempted to make a ST bearish bet and so if I was tempted I'm thinking many of the bearishly inclined must have pulled the trigger and are now underwater. Being short the market as it's making new all time highs is usually not a good spot to be in because fresh all time highs tend to result in more all time highs. It would appear to me that barring some significant negative bad news,  pullbacks should be relatively shallow.  

Energy stocks sold off earlier in the month but are rebounding today as oil and nat gas are rallying today. The more I think about the energy complex, the more I'm becoming a weak holder. I mentioned in my last post how the cat is now out of the bag with respect to the energy crisis. This awareness has resulted in a major shift towards energy stocks from so called "institutional money" as indicated from BOAs  most recent Global Fund Manager survey. It's the exact opposite of what they did in August when energy stocks had been selling off and making a low. Financial are also being chased.  Rising energy prices are not necessarily bearish for the market in general until they get to the point where they have risen "too much" . Where is that point? I've read that it could be around $140 oil. 

In addition to the exuberance in the energy complex there's evidence of extreme pessimism in bond which goes hand in hand. All of this suggests we are close to the peak inflation narrative. If that's the case and we see energy prices and bond yields cool off, that could provide fuel for the markets to power higher barring that the decline in inflation pressures are not the result of collapsing economic growth. I'm seeing hockey stick charts when it comes to inflation related pressures and rates of change in commodity prices. Some might say that this constitutes a long term break out, but it could easy well be largley the result of the supply chain disruptions were a seeing which not only results in lower supply but also hoarding. I've been reading stories about how the warehouses for major commodities like copper, zinc and nickle are a very low levels.

This whole supply chain disruption is making me rethink my thesis about the commodities complex in the short to medium term. Once we start to normalize we could see at least a 6-12 month period of disinflation which would hurt the entire commodities space, especially energy. Although there has been a lack of new investment in energy cap ex, there is more ability for a supply response compared to that of  metals. In addition, high energy prices may speed up the transition to electric vehicles and so you could have negative demand pressures on energy forthcoming. With metals on the other hand, the demand side is slated to have positive demand pressure long term for the same reasons - electrification.  So, if 2022 ends up being the year of disinflation which hurts commodities in general, I could be a strong holder of my copper/mining plays but not my energy plays which I have already reduced by 50% and am looking to sell more into strength. 

I am also looking to initiate a position in LT calls on TLT given the contrarian condition of bonds. It will also nicely offset my positions in commodity related stocks. I also have a healthy level of cash. You always need to put yourself in a position where you could be strong holder. This is what I'm doing. 

The energy cat is out of the bag

 First off some market comments. September was rather nasty living up to its reputation. We had Evergrande fallout fears, debt ceiling fears and inflation fears creating the jitters. It's the latter that you should be most focused on, the other 2 are just noise in my opinion. Rising inflation fears creates selling pressure on bonds and when yields rise it is typically negative for the markets.  The culprit is rising energy prices, we saw a similar thing happen in May. This time around the nat gas price is taking the spotlight. It hit all time highs in Europe due to perfect storm of low nat gas storage, coal shortage and below average power generation from wind power. Sentiment wise, we are seeing a marked rise in pessimism and unwinding of bullishness, mind you, there wasn't as extreme bullish sentiment condition at the recent market peak. There is room for sentiment to become more bearish before I think there would be an all clear. I also read about how coming into September Global Fund mangers were complacent and had a low level of hedges in place.  That complacency no doubt has been at least partially washed away. There's also signs that economic growth will be downshifting....not a good time for this when energy prices are rising.  Bottom line is that at this moment,  I expect to see the market chop here and possibly retest or break the recent low by a bit, but nothing more than that. Take a step back here and look at the bigger picture. The market is still up nicely for the year and the correction so far has only been about 6% in the SPX. Even a 10% correction would not be that serious if you look at how much ground the market has gained in the past 18 or so months. 

On the topic of energy, I mention in my last post and also back in May how there could be a energy crisis due to the shunning and subsequent underinvestment in fossil fuels due to ESG and green tech. Well, this is what's happened and now the cat is out of the bag. I've seen several articles pop up in the financial media stating the exact same thing. So, now that this narrative is out there front and center, I'm debating what to do here with my all my energy holdings because I know from experience that this could be a signal that the bullish news for energy could be priced in, at least in the short term. The stocks are at or close to very ST overbought levels. To quote Jesse Livermore "be right and sit tight" which means you have resist the urge to exit your positions prematurely. Selling just because you are showing a profit is not necessarily the right or even prudent thing to do if you have good reason to expect higher prices in the future. Sitting tight was easier for me to do when I initially bought my positions back in March/April because I had good reason to believe that I was still picking low hanging fruit. But now that the cat is out of the bag, the stocks are overbought and I'm seeing victory lapping on twitter from energy longs we could be close to a ST peak here. As such I'm  looking to trim 40% of my positions. The risk of me doing this is that we are at one of those long term inflection points where the generalist investor capitulates and gets back into the energy sector in a big way. If that's the case, there will be a relentless bid in these stocks and pullbacks will be shallow. Tough to tell if we are at that point yet. If not, we could see quant funds and retail types bail en mass if energy prices cool off in the near term  like what happened in July. US crude inventories are building and Russia says it will provide increased supply of gas to Europe. This is all happening at a time when global growth is cooling.

So, bottom line here is that there's good reason to be ST cautious on energy but even if O&G prices see a notable correction the stocks in the sector will still be relatively cheap generating tons of cashflow. Of course, there's always the bearish case that this energy move is a one and done thing and the green energy revolution will accelerate faster than expected. Tough call here for me. So, this is why I'm looking to exit 40%, this way no matter what happens I won't have too much regret either way. There's also a ST opportunity to deploy the money in other other commodity plays. Copper stocks for example have been drifting lower since May despite the fact that copper has has been holding above $4/lb.  Again, the cash flows that are being generated  for copper producers will be quite substantial making a  lot them look quite cheap. Given the current growth slowdown, this will be a good test of how durable the copper price is in the ST. In the LT there is a huge underpinning bullish force in place if you assume that we continue the quest for decarbonization. It will require copper prices of at least $5-$6/lb to produce the quantity of copper that is required to fully or mostly electrify energy consumption cleanly.