COIN - February 1 Likely Sell-Off: Aftermath Brings Neither Bull Nor Bear In 2023

Summary

• My last article explains why Powell will disabuse any notion that the end of fast and sharp rates coming to an end means that liquidity returns.
• I listed a number of non-raising tactics he could implement that will take away the proverbial "Punch Bowl".
• The fact that the 10 Year Treasury has sunk so low that it has invited renewed home sales and rising home prices is not lost on Powell.
• All that said, what kind of market might we have in 2023? Also, what is the best approach that will help preserve one's principle while at the same time afford better chances to generate alpha.

Market Crash, or New Bull Market? There is a Third Way

Cause for optimism

Over the years I spent a lot of time on where the market is taking us. I have either bravely or (some have said) irresponsibly made predictions on where the market was taking us last year. I admit the results were not always to the level of success of previous years. Since we’ve all lived through the market craziness I don’t think I need to list excuses, nor do I want to excuse myself. If you are still reading my writing it means you have taken into account my misses and hits, and for that I am grateful. Even though I approach each new year with optimism, I believe we have logical reasons to be so this year, as well as being equivocal. For one we will have less government interference in our economy this year. As a market participant no matter what your political leanings are, you know the pouring cash into the economy will now end. Both political parties are guilty of overspending and finally, after the last decade and a half of profligacy, the economy erupted in soaring inflation. I also believe there are plenty of reasons for caution. This will be played out in the coming months. The goal of this article is to put into words what I and the Dual Mind Research community have arrived at organically as an ongoing strategy.

Cause for caution

Just as one can point out reasons for optimism, there are equal reasons to justify pessimism. First on the list is the massive decision Powell will be making on February 1 as inflation slowly dissipates. In my last article, I laid out the actions that Powell might take in order to keep a lid on inflation . Money supply growth is Powell’s bugaboo, having squeezed out froth from stocks and suppressed demand from home sales by rapidly raising the Fed Funds Rate beyond 5%. As a result, the M2 Money Supply has plummeted check out this chart courtesy of the St. Louis Fed.

Powell wants to hold down money supply growth, which means no frothy risk-taking, no increase in wealth creation, and in turn no increase in consumption due to an increase in Jobs. What increases the money supply? Credit card purchases, rising home prices, and increasing home equity loans. Rising home prices have been shown to increase spending on their own. Also rising home prices translate to higher rents as well. The reaction of the bond market over the last several plus months is a retreat of the 10-Y to well below 3.5%, since the 10-Y influences mortgage rates, we have seen mortgages as low as 6.07%. As much as the Fed has raised rates and continues to do so we see home sales reignite and a recent leap in Lumber prices once again confirms higher demand. Even as Powell is lowering the rate rises from .75% to .50% (last month), and now .25% is expected. Most commentary has the Fed raising one or two more times and will cease. Clearly, Powell knows that as soon as he lets off the rate rises, rank speculation in markets, and home prices will soar all over again. In fact, it has. Since hopefully reading my previous writing, I highly doubt Powell will take it sitting down. At stake is his place in history as the Fed Chief who brought high inflation back. Of course, it isn’t all that black and white. It will take nerves of steel and a steady hand navigating the US through the shoals of hikes already executed, and whatever creativity in tamping down.

So far, the economy has proven to handle the raises. As Fed President Raphael Bostic eloquently expressed last November; “ the "long and variable" lag between a monetary policy action and its impact on the economy, … A large body of research tells us it can take 18 months to two years or more for tighter monetary policy to materially affect… it takes businesses and consumers time to recognize, feel, and act on changes in financial conditions”. I chopped up the text for brevity, and not doing his fine prose justice. Just click here for the full text . This means that we may not yet be experiencing the full force of the rate raises just yet. We will likely go through stock-market cycles of recession fears and optimism for renewed economic growth. We will see evidence of disinflation and fear of deflation. A recession with deflation is known as a depression. Yes, the same economic condition that caused a worldwide economic calamity way back nearly 100 years ago. Few people alive today have any recollection of those desperate times but we still live with institutions that were put in place to counteract the worst fallout from such a condition. No, I don’t believe we will see an actual depression, however, I can tell you that the condition that worries the Fed the most is deflation. Japan has been suffering for decades over deflation and is only now making tiny progress against it. Any evidence that recession gains the upper hand this year will produce historical comparisons to 1929 if we see lower prices coinciding. I don’t expect a steep recession, but the economy may display negative growth for several months as winter turns to spring. This will give the perma-bears plenty of ammunition to make noise and draw attention to whatever snake oil they are trying to sell.

My thesis; forces for and against recession, for and against a bear market will equalize

Let’s stick to the central topic; the proper approach to succeed at the market we have now. That means being able to confront the challenges that will be unique to 2023. With less monetary largesse the economy can recover and start acting more like the free-market capitalist one our founders intended. As more and more data show less inflation growth the Fed will have to cease raising rates at some point this year. In one of the areas that I was correct in 2022 and said it numerous times; this economy can handle higher rates. In fact, this is an act of normalization, meaning the zero-rate program was unhealthy for the economy. We see this in the crypto bubble of the last several years but also the “zombie companies” that could keep going to the well of share sales or borrowing at zero. We are starting to see companies of all sizes responding to these higher rates by rightsizing their staff and cutting projects that had little chance of bringing profits to company coffers. Unfortunately and this is the most fraught variable to deal with is Jay Powell’s fixation on jobs and wage growth. The stubbornly high job growth and lack of unemployment is the red flag that can cause Powell to push the economy into a deeper recession. I don’t think this will happen but it will be a recurring narrative to gin up fear and cause periodic selling for 2023. Eventually, the continued disinflation will persuade him that strong employment does not necessarily create too much demand that can reignite inflation. The release of employees from large companies that were hoarding them, or due to automation will migrate to smaller enterprises that sorely need that workforce. This has been an ongoing thesis of mine since last year and I believe it is starting to show up in the numbers.

So I started this article with the notion of the third way, what do I mean?

First, let me dispel the notion that this is some profound and nuanced insight. It is actually very simple, the third way is neither a bull nor a bear market will hold sway for 2023. Following my assertion from my last article is that Powell will not let the cessation of interest rate rises to allow out-of-control consumption. Pressure on prices could reignite inflation, on the other hand, inflation is starting to take the back seat and allow for optimism in the stock market. These two forces, of constraint from high-interest rates and other ways of draining liquidity, and bullish developments like signs that the recession will be mild will cancel each other out. The result will be a long-lasting consolidation phase, beginning with high volatility will begin with a sell-off on February 1, when Powell once again has a “Jackson Hole” moment. He will disabuse the notion that long-term interest rates should be at 3.5% on the 10-Y. How he does that might vary widely from my description in my last article, but rest assured he is not happy that Bitcoin is over 23,000, or that mortgage rates are dropping. He has to thread a very tiny needle, but I believe he will do it. Let me also state the obvious, if it requires that Powell needs to throw the economy into a recession he will do it. This is the “Sword of Damocles” that hangs over the head of the bulls, just as the cessation of interest rate rises hangs over the bears' heads. So the year will go back to high volatility from February 1, and probably rage into April. Eventually, both sides will have exhausted themselves and a steady state will ensue. It will probably be much messier than I am laying out here. So what path did our community at Dual Mind Research arrive at?

Again this is in no way some secret knowledge that no one has discovered before. Long and Short positions.

We are basically picking stocks for a long and short strategy. Many hedge funds act this way, though when the market is in a sustained bull market a short strategy becomes vestigial. Most individual investors and traders have lived for the most part in a bull market. In the last few years, we have experienced the swipe of the bear claw as well. My long-time readers have seen my evolution from an (at times) over-optimistic bull to a bull that also used hedging heavily, to know who is using their stock picking skills to find stocks that deserve to be trading much lower as well as stocks that will go higher. Stock picking was always my first love, and because of that I learned the importance of being able to suss out where the market is going. Stocks do best when the market is rising, alternatively, stocks do well when a particular sector is rising. So when the overall market falls some stocks fall harder than others. When a sector is in trouble then certain members of that sector will suffer more than others. It is that simple rule that we have used to select winners and losers. So when the market is consolidating, there will be many opportunities for a long and short strategy. So let’s talk about actual positions that I have taken on the short side for now, the long side hasn’t really changed. I express my shorts through Long Puts. Also, my hedging hasn’t changed as much.

My Trades

So here is where I am in prep for next week:

• 20% cash

• Hedging by long Puts against Triple Qs ETF ( TQQQ ) at the 20.50 and 20 strike

• Long Puts Bed Bath & Beyond ( BBBY ) February 24 at the 2 and 2.5 strikes

• Long Puts Coinbase ( COIN ) March 17 at the 35 strike

• Long Puts Carvana ( CVNA ) February 24 at the 7.5 strike

• Long Puts DoorDash( DASH ) March 17 at 45 strike

• Long Puts Nordstrom ( JWN ) Feb 24 at 17.5 strike, March 4 at 17.5 strike, and March 17 at 19.5 strike

• Long Puts CarMax ( KMX ) April 21 at 60 strike

• Long Puts Kohl's ( KSS ) March 17 at 30 and 32.50 strikes

• Long Puts Southwest ( LUV ) March 17 at 32.50

• Long Puts Wayfair ( W ) March 3 and March 17 at 55 strike

I am way underwater on DASH, CVNA and LUV. I expect that to change going into Feb 1. If not I will close out all my winners and losers next week. If I hold on to any of them, I will have to have a good reason, and not hold on to a losing name because I don't want to take a loss.

Note:

I believe that select retail is way overvalued, especially used car sales and multi-brand retail. In addition, there are special situations, LUV is a broken brand. It is one snowstorm away from another fiasco. I don’t want anyone to be stranded in an airport for days on end, but anyone flying LUV needs to think twice about getting into Southwest airliner without consulting long-term weather reports. I think a lot of flyers will opt for another airline if the fairs are a few dollars apart. With DASH it is basically my short thesis that is dependent on the Instacart IPO. I think Instacart going public will cause anyone bullish on this sector to sell some DASH to get in on the Instagram IPO. Also, I just think DASH is overvalued right now, compared to Uber Tech ( UBER ) which is supposed to be profitable, currently, it is cash flow positive. BBBY is going bankrupt so no big science there as to why we are short.

Finally, let’s be upfront here. January gave us a wonderful rally, the SPX is up 7%, and the NDX is up about 11%. That is a full year of gains compressed into one month. Does anyone think that the market won’t fall back on any negative input that Powell will provide? I suspect the market will continue to be elevated for the first few days of next week. If so, do the smart thing and take some profits at least. Have a great week!

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