2022 the year of the hangover

Market's have gotten off to a rough start especially the tech sector. In a recent post I mentioned how it was suprsing to have seen the NASDAQ held up so well in 2021 despite the bloodletting in the speculative unicorn tech stocks which had paralells to the 2000 bubble bursting by which the NASDAQ eventually gave up the ghost in the last 3 months of 2000. Could it be that now we are seeing the same type of fallout happen in tech and that the 2000 paralell is actually still in tact? There's some strong evidence that suggests this could be the case but there's still some notable holdouts, the biggest one being that it was a collapse in tech earnings which ultimately did in the sector which was the result of over-investment in the telecom. If you look at the tech leaders of today , the FANGS, they each are dominant players in their respective spaces which aren't nearly as interconnectd as the tech leaders in 2000. The latest selloff in the tech space had been directly a result of the spike in longer term government bond yields thanks to a hawkish Fed pivot early in the year. This resulted  in rug pull which was amplifed because of of poor sentiment positioning conditions which I noted in my last post. There's some signs that sentiment positioning is improving however. According to BOA, global fund mangers have significatnly cut back on their tech exposure this month, in fact, they have the most underweight tech since Dec 2008! And what did they pile into? Financials of course, which has been the second strongest performer, energy being number 1. Financials too are now getting hit.   Now, it's one thing to dump tech because of poor fundamentals i.e. earnings but it's another to do so simply based on the yield of the 10 year s going from from 1.5% to 1.85% . Of course, the fear is that it's yields are going to go even higheer. At first this sell-off looked feels knee-jerk in nature and it so happened at time when the market was vulnerable in the ST due to poor positioning/sentiment. But now there's so much calls for the Fed to "do something" in order to stop inflation and that of course means aggresive rate hikes. No wonder the market is spooked. But the sad thing is, the Fed is not the main cause of inflation (aside from housing) and they can't fix it other than by creating a recession. The inflation is being caused by supply contraints and excessive government spending. Raising rates abruptly can tank the economy and therefore demand. Sure, that will curb inflation but not by addressing the actual underlying cause. That's like getting gangreen on your toe and cutting off your entire leg to treat it.  

On a bigger picture perspective, there's definatley things to be concerned about in 2022. We have a hawkish fed that will be raising rates sooner than what had been expected just a few weeks ago. One of the risks I mentioned earlier when discussing the expectations for 2022 was for a revising of rate hike expectations to the upside. The Fed is being hawkish at a time when some forward looking indicators of global growth and therefore inflation will be slowing.  That clearly puts the risk of a policy error much higher. The amount of fiscal stiumuls is also not going be as much as last year but it's not going to be abruptly taken away either, however, that's still an incremenatl detractor to growth. So it definatley feels like the market is walking on a tightrope here and 2022 could be a hangover hear as stimulus is being pulled back. Earnings ultimatley will be the deciding factor longer term but because valuations are historically so high, along with margin debt, it might only take an modest amount of monetary and fiscal tightening to create a big market decline. If earnings don't implode, once the market sniffs out the end game to the Fed's tightening, things will settle down and the bull market can resume. I can't give the bulls the benefit of the doubt on that. At best, it would appear that a drawn out trading range can hope for during the next 6-9 months. It seems probable we will see something worse. There was too much excesses last year, more so than I had orignally thought. This chart of global fund flows is scary. It seems unlikely this can be unwound without a major correction if not crash. Look at that last peak  in 2018 which was a bad year.  

The latest rotation of value into growth has been quite vicious lately. Last year we had a back and forth market between value and growth and they basically preformed the same. This year value is clearly ahead so far. Is the back and forth rotation from value to growth indicative of a changing of a the guard wherby value will become the dominant style? It sure that way. There's a lot of evidence that suggests it could be value's time to shine. For about the past 10 years growth has trounched value, with about double the peformance. The last time growth had such a dominance was in 1990s, from 1995-2000 in particular culminating in blow-off peak of the dot com mania. We very well could have whitnessed a blow-off COVID mania with disruptor/unicorn tech stocks and crypto being the bubble that burst. 

You can see that the recent value outpreformance last year was a headfake but now it's threatening to break out to the upside. You can also see how back in 2000 a similar pattern occured. Energy and commodities were the largest drivers of the value back then. Will they be again this time?  We know the narrative for Energy i.e. oil and gas has been one of secular decline due to the rise of electric veichles but we have shunned energy development for so long and now it's payback. In the ST however it does appear that chasing energy here is not prudent as others appear to be doing right now. Bullish sentiment on energy is quite high. DSI for crude is 92.  OPEC is expected to increase supply in Feburary and gas inventories are high. 

Bottom line is that I am officially market agnostic if not bearish for this year. I will not be giving the bulls the benefit of the doubt which means I will be tactical and not just stay the course when the market hits overbought conditons. The market sure looks sickly at this moment. Let's see if sentiment surveys and fund flows tommorow finally show signs of capitulation. Tech earnings are slated in the comming weeks. If we finally get some capitulation and energy prices back off we could get a nice snap back rally.  The only reason I'm not outright bearish is because we still did not get all the classic signs of a secular bull market top which is inverted yield curve, investor greed and rosy optimism in general. This makes me think that no matter how bad this year gets, it may be salvagable and just turn out to be another nasty correction in an ongoing bull market but I'm not holding my breath on that.  

Poor sentiment positioning hampering the market. Expecting more ST downside

Comming into the end of the year there was a massive $25Bweekly inflow into equity funds. After this week's decline you would figure that sentiment would have turned negative, but no. Another weekly inflow. Not as big but a solid $9B. This is not good. It shows too much hope. NAAIM is another indicator showing way too much bullishness given the poor market action. I also was expecting it to go down this week but instread climbed to 89% long. That made me cringe. Only AAII sentiment ticked down. Put/call ratio is also starting to perk up but all in all, there's not enough pessimism to mark a low here in my opinon. 

Expecations are tempered for 2022

The market was able to shake off Omicron and inflation fears in December and closed a little bit off all time highs. It was a strong showing in 2021 being one of the lowest volatity years on record. Pullbacks were all shallow being no more than 5%. 1995 was the closest resemblance. Earlier in the year I was getting concerned with the speculative fevor going on in certain parts of the market namely in the unprofitable/unicorn tech space aka the ARRK stocks and meme stocks. These were signs of euphoria which is what you see near major market peaks. The bitcoin frenzy was also a sign.  In March I made the comparison of the run up leading to the dot com mania peak and what we were seeing at the time. There were clearly some notable similiaries but differences as well. The bears were only focusing on the former of course. But the market did something that was rather remarkable.The undoing of the eurphoria in the speculative sections of the market did not spill over to the broad market. By mid year the high flying tech space tanked with a vengence while the board market simply carried on making new highs. The NASDAQ did lag slighly but not even the biggest bulls out there like Tom Lee expected the NASDAQ to have held up so well. .Throughtout 2021 New covid waves,  inflation fears, Fed tapering and tighting have all put a damper on sentiment. The strong US dollar was also a surprise to many but not to me as I pointed out in early 2021 how bearish sentiment towards the dollar was extreme. 2021 was also characterized by vicious rotations from growth the value and vice versa. Lots of active managers/traders got chewed up by this and so even though 2021 was a bengin year when it came to volatility, that was only the case if you did nothing but held the market index the entire way...and as often  is the case, that's the best way to go in a bull market. Hedge funds and active manages as a whole once again underpformed the SPX. Think about all the stress, time and effort that goes into managing a hedge fund only to realize that come the end of the year you did worse than a lay investor who simply bought the market and did nothing else. 

Comming into 2022 expecations are clearly tempered with the Fed set to taper and raise rates 3 times and fiscal stimulus set to downshift. There's also a lot of complaining/worry about how the breadth of the market is poor. I'm not going to go into great detail but suffice to say that not all measures of breadth are poor such as the equal weighted SPX which returned just about the same as the cap weighted SPX. It surely feels like investors have their guard up. "How long can these good times in the market continue?" is the question that's on everyone's mind including mine. But you see, this is why the market continues to surprise people on the upside - low expecations. It's been this way for the most part since the bull market began in 2009. Along the way there were a few times where expecations becaome too complacent which then led to corrections and these corrections ended up re-reseting expecations quickly back to pessimistic again thus allowing the bull market to resume. I believe the reason why expectations are so easily able to revert back to pessimsism is because there is an ingrained disbelief in the bull market and/or a fear another a major crash like 2008. Many of today's investors have scars from 2008 and 2000. We can now add the Covid crash of 2020 to this list.  I also get the sense that even most of those who have generally been bullish have a sort of "one foot out the door" type mentality. I include myself as one of these people. I'm sure more investrors are asking themsleves "how long can this go on for"" as opposed to "I wonder how much money am I going to make this year".  

We know from history that the stock market doesn't get into big trouble untill monetary and fiscal condtions get tight while co-inciding with historically optimistic sentiment or at the very least complacency.  We are going to enter a period where monentary and fiscal are going to get tighter but would still be classified as easy. Everyone is expecting these tightenings and so there's no suprise factor here unless the tigheninings become greater than what's expected. Lots of people are also concerned about a possible policy error. Therefore, all of this "taking away of the punch bowl"  should be priced in and it would appear to me that the market is more inclined to  re-rate bullishly rather than bearishly. So long as interest rates across the board are historically low and corporate earnings solider on, the market should remain generally boyant. Dips/corrections will happen no dobut, but they should be just noise unless there's a major negative surprise. Inflation is poised to decelerate this year simply due to base effects alone but also due to declining commodity prices and hopefully this latest Covid wave will be last major one. It appears that it could be the case given the weaker strain of Omnicrom. It's also encouraing that most governments around the world are finally accepting the notion that Covid is something that we may have to live with forever and that draconian lockdowns and quarentines are not the solution. This should lead to less workforce shortages going forward which was a major contributing factor to inflaiton in certain goods and services. 

A potential achiles heel for the market at some point could be the crypto space which hardly anyone expects to be a risk for the broader economy. I continue to be a skeptic and the question I'm asking myself is how much of a misalloaction of captial has gone towards this space and how bad will the fallout be now that instituional money has gotten involved? The dot com implosion ultimatley led to a reccession in the economy. Has cyrpto infected the broader economy large enough to take it down should it implode? This is an important question I need an answer to because I believe the jig may be up for crypto. 

Market destroys bears....again

It's been a relentless rise as the market keeps making fresh all time high after all time high. In my last post I suggested that pullbacks would be shallow...what pullbacks? It's been nothing but pain for bears who got trapped shorting that first big rally from the bottom in early October. So now what? Well, pretty much all short term indicators are redlining here which suggests at the very least that the market is due for an immanent rest but I suspect that rest will be relatively shallow and short lived and we close out the year at a high. We'll see. I reserve the right to change my mind if evidence suggests doing so. I've sold almost all my energy holdings at this point. We'll see if I end up regretting that. 

So what's causing this rip higher in the market? I think the market is sensing peak inflation here. Remember, inflation scares are what caused bond yields and energy prices to spike and markets to sell-off in September. Now we've recovered all those losses and then some. Freight rates have rolled over energy prices have stabilized and are are possibly rolling over,  and there are early indications that some supply chain bottlenecks are starting to subside. I read how Ford and some others have reported that chip shortages are easing.  The big bad tapering event this week turned out to be a non-event which caused further FOMO capitulation. 

The key to this market all year has been to avoid chasing/embracing the narrative of the day. In my last post I mentioned how financials and energy were being chased and therefore due to underperform. That has certainty been the case. Growth and US stocks have resumed their dominance since mid May. For many months Ken Fisher has suggested that the COVID decline was a large correction in the bull market that started in 2009 and therefore the sectors/factors that were leading prior to COVID should eventually resume their leadership. It looks like he's going to be proven right especially if inflation pressures subside and we get back to low but stead growth in the coming months which seems poised to happen. The huge fiscal boost we've gotten during the past 2 years is set to subside significantly next year. 

So, the big question is, how does this all end? When will the next big bad bear market happen? What we've been missing is the full embracing of the bull market at a time when monetary and fiscal conditions are unfavorable. We've seen some instances over the years where froth was apparent like earlier this year, but then we would get a shakeout that washed out the froth and revert it back to pessimism/skepticism. I don't know what it will take for us to get the ultimate peak but there's certainly some late bull market stage indicators out there. Margin debt levels, the  high level of quit rates for example. Will next year's fiscal drag be the trigger to cause a bear market or at the very least a 20%+ correction?  Stay tuned ad stay vigilant... 

 

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.  

Steady as she goes

Since my last post the market has been grinding higher with a couple of modest dips along the way. It's been acting as I'd expected. There is still a tug of war between value and growth with the latter getting the upper hand as of late but there's some burgeoning signs that value has taken back control, the energy sector in particular, which had a notable correction in July and early August. The correction was mainly triggered by fears of the Delta wave and its potential impact on demand. The correction appears to have washed away the weak handed johnny come lately and momo traders. I saw a report from BOA mid August that showed global money mangers had fled the sector in July after having piled in a couple months prior. With natural gas and oil prices remaining firm, the energy sector won't be able to be held back for much longer. The FCF generation relative to market value is already high but it's going to be enormous come Q4 and Q1 2022 because a lot of companies in the O&G sector put on hedges in 2020 which for the most part will be will rolling off in Q3. These hedges have been capping profits this year, especially in the nat gas sector.  With nat gas prices well north of $4/mcf  these companies are absolute monster cash cows once those 2020 hedges roll off. Even at $3/mcf, most of these companies will produce a gusher of cash flows. This should result in significant dividend hikes and/or share buybacks and also acquisitions. 

Nat gas prices have been notoriously volatile and in the doldrums for 15 years, however, because of the anti-fossil fuel movement and ESG push, new investment in oil and gas has been well below average for quite some time and was cut to the bone in 2020 due to COVID.  We've been  shunning  O&G too much. This will have consequences and we could very will have an energy crisis in the next year or 2 because although the future appears to be one of electric vehicles and clean energy, we aren't gong to get there overnight like what the clean energy and ESG hypesters are implying in my opinion.  And here's another thought...what if there's a breakthrough in carbon capture technology that either makes it more affordable and/or more effective? That could provide a new lease on life for the O&G sector. Don't get me wrong. I do envision a future where we no longer use fossil fuels and the solar and wind sectors will continue to be growth sectors in the long run, but we can't just turn off the fossil fuel taps as abruptly as Gretta and her ilk want us to. 

Getting back to the general market, it continues to be a goldilocks type environment. Everyone seems to be looking over their shoulder for the next big correction but that's tough to get without sentiment becoming excessively bullish. The lack of extreme bullishness continues to be case. Anytime that sentiment starts showing early signs of giddiness it quickly gets washed away on just a modest dip. That's wall of worry behavior which underpins a bull market. We're seeing the market roll over a bit here...let's see how people react it. So far I'm already seeing fear pick up notably. There's a concern out there about market valuations being high which does appear to be the case when you look at traditional measures such p/e ratios and such. I don't want to cherry pick bullish arguments, but Fidelity Sector Strategist Denise Chisholm (who I find is a hidden gem) makes the case that earnings are poised to accelerate more that what's being expected which means the market isn't as overvalued as people think. The concern about valuation is also indicative of the wall of worry. Near a bull market peak you will probably not have such concerns. People will find justifications for high valuation like in the late 90's rather than worry about it as they do now. 

Bottom line is continue to look for long set ups and resist the temptation to short.  If you must, raise some cash if that's gong to make you a strong holder. People who have used stops loses and  made trades based on trend lines, support/resistance lines and such have been chewed to bits.