ACTV - Great Rally Yet We Started Hedging Why? I Explain

2023-04-03 03:13:08 ET

Summary

• It is easy to feel like a genius when stocks are rallying. Instead, keep your feet on the ground by understanding the market rhythm. I attempt to explain that with charts.
• Stocks seem to shrug off scary news like the bank crisis. Could this finally be because of that "Powell Pivot"?
• The market message might be a soft landing, but it will take the skill of a "Sully" Sullenberger landing to get us down in one piece.
• Hedging is very much part of the Cash Management Discipline. It is there to relieve anxiety and keep your mind in the game.

Will Powell become our "Sully" Sullenberger? The market might be telling us so

If you’ve been reading my public content you shouldn’t be surprised by the rally we are enjoying, yet many commentators are still looking for the market to crater this year. The lazy answer is that we are nearing the end of the rate rises so naturally the markets would go higher. Yes, and yet it didn’t feel like we were going anywhere for quite a while. However, as you look at the 6-Month S&P 500 chart below the market has been rallying for the last 6 months albeit in a rocky fashion. Still, even as all the, or nearly all (not me), commentators were saying that the October low won’t hold and that at least one more try to break meaningfully below the 3500ish level, should be successful. Yet it didn’t happen. Instead, the most hated rally in memory ensued, particularly difficult was the year-end head plant that left everyone sore, grumpy, and happy to turn the page on 2022.

Why should I remind you of the difficult near past? Well, to know where you are going it is best to remember where you came from. Even as inflation remained stubbornly high and Powell was denying he was about to pivot. Instead, the Fed moved rates ever higher, at some point those higher rates would drive us into recession. A funny thing happened, inflation started to improve and the economy held up very nicely, thank you very much. So is the market just rallying on that “Powell Pivot” many of us have been salivating for? Although I still feel that volatility isn’t over, and let’s be honest, a hasty retreat is not out of the realm of possibility. After all, there could be another Silicon Valley Bank lurking in the bushes getting ready to give us a good April Fool’s scare.

If we can get into the market rhythm and understand the price action we could turn this up-and-down market to our advantage. Let’s take a look at the next two charts. I have been sharing this chart with my Dual Mind Research Community for several weeks and may have blogged this out as well. I think it engenders some confidence in how to deal with this market. There are a few simple terms to understand, there are the undulating horizontal lines the green one is the 50 DMA (daily moving average) and the blue line is the 200 DMA. When the 50-Day rises above the 200 DMA this is a bullish signal called the “Golden Cross” the blue vertical line just shows where it intersects. So you see that once this happens we have a nice rally. The next vertical line in red is the bearish signal called the “Death Cross” meaning that the rally has lost its oomph. Once again we have this vertical blue line giving us another powerful signal of upward movement. If your eye continues along you can make out that we are just about to have another “Golden Cross”. This is great news, and it overlaps very well with current events as well.

Yet instead of leveraging up further, I started to hedge as the VIX dropped significantly below 20. The lower the VIX the more brittle the rally becomes. The chart below hopefully illustrates why I have executed hedges using the VIX and the 3X VIX ETF ( UVXY ). I do believe that we can go higher, but I also know that this is a stock market that can turn on a dime. It has proven that over and over again. So maybe we run up to 4150 and then give back 50 to 100 points before it starts marching up again. I would rather buy a little insurance so I can sleep at night. I ended up hedging even more.

If we are about to have another “Golden Cross” Why start hedging now? First and foremost While I am the captain of Dual Mind Research, I also have the humility to listen to the group. While we are almost a year old, we have built up a level of group knowledge that I value. I was already moving to hedge via the VIX and UVXY. I pledged to the group that if we hit 4100 on the SPX just this Friday I would hedge alongside the group. Part of me was skeptical that we would get there and stay above 4100. When we did, it did feel right by my judgment to hedge further with the community. Added Puts on TQQQ and SPXL in response, in the back of my mind was this next chart. The VIX thank goodness has something to tell us.

The VIX has returned to normal

The VIX is normally referred to as the “fear” index. I must have shared my gripe that the VIX wasn’t behaving “correctly”. It had become useless as a forward indicator of market direction. That is until recently, now most people refer to volatility as the market going down. No one seems to care about volatility if the market is spiking. So too with the index the VIX is fixed to which is the S&P 500. Previous to the first set of black lines (in the 3-month chart above) the VIX did not react at all to the upward movement of the S&P 500. Once you see these black lines are the first time in a long while that the VIX dropped under 20. I put these lines in by hand while reading the historical data, plus the above is the S&P 500 ETF (SPDR) so there might be some slight differences to the actual S&P 500. The green lines are the first time in quite a while that the VIX spiked into the high 20s and at one point hit 30. This means that 1) the VIX is working like it’s supposed to 2) It is now a valid forward indicator 3) the final black line to the far right should mean that we are overbought and could have a bit of a retracement to a lower level. This doesn’t mean the current rally is over, no, it just means that the SP & 500 remains volatile. A quick look at this chart will confirm that the move upward is done in steps. I think this rally that I have talked about in prior articles has legs. We broke nicely above 4100, I would expect a bit of a tarry here, and then quite possibly get close to 4200.

What could take us lower, and what could take us higher

The market loves visibility, meaning that we have a narrative that gives a clear shot at the near future. I’ve often remarked about that, and it is very important. The moment the present and near future lack clarity, even if there are 2 clear choices and both aren’t dire, it will still perturb the market. Part of the reason is that the market is a forward-looking mechanism. You can’t create an option for the past, and I am sure you’ve only heard of futures, right? So right now and perhaps into the end of the year the market knows that A) interest rate rises that were going to go faster (.50%) are now for sure staying at .25% B) Powell is done raising, or maybe one more (I doubt it) C) the Bond market is telling everyone that not only has he stopped rising but he is going to cut rates this year. D) The banking crisis is not a crisis, though there are assumptions that loans won’t be plentiful. As an aside, I think loans will be more expensive but businesses won’t be left out in the cold. We have a huge “shadow” banking system that is only too eager to lend. So there is a case for a soft landing, however, the pilot will have to be at the level of “Sully” Sullenberger to get us down safely. Right now the market has decided that Powell got his “break” from the banking scare and it’s time to get us down in one piece. This is all good news, What could take us down to the October lows? This alternative path is also clear, inflation starts ticking up, or the consumer stops spending. So far, the economy has taken the higher rates in stride, and if you stand back and look at history; 5% to 6% Fed Funds Rate (FFR) is pretty standard. No one has ever jumped up rates so fast, and that is the test we seem to have passed. Ironically perhaps, inflation due to all this money pumped into the economy has given the consumer the extra oomph to skirt a nasty recession – that is if we are really lucky. It would have been much better if government largesse stopped sooner, and Powell reacted faster. Like I said about stocks the economy also looks forward and from where I sit the sun might just come out tomorrow.

Why this bit of optimism?

If we were teetering on the edge of disaster, there would have been much more collateral damage from the bank crisis. Something could still happen, but it didn’t get kicked off by the insolvency of Silicon Valley Bank, the 16th largest bank in the world. So I think the market is sniffing out that we could handle the next shoe to drop. Where is that shoe dangling? I think all these private equity companies running their single-home rental businesses, could be in line for some comeuppance. Rents are coming down and interest rates are inching up. We could have a housing deflation scenario, that sounds wonderful but might just kick the recession into gear all by itself. The more obvious scenario that everyone is talking about is the commercial office REITs. I think they are too isolated to take down the whole country since it is just New York City and San Francisco in trouble. Yes, I think that part of this rally is growing optimism that Powell could make like Sully and give us maybe not a conventional soft landing but at least everyone comes out alive.

Ok now back to the situation at hand

Here’s the picture, the VIX is once again below 20, and we are about 4100. The rally in my view is not over and there is enough good visibility to take us to +4200… Maybe. The lower the VIX gets the more “brittle” the rally will get, and could even fall of its own accord. I expect the market to consolidate a bit and start moving higher – as long as inflation keeps ticking down, and there are no new economic accidents. It is only right that stocks celebrate the end of tightening being visible, so yes 4200 is a possibility, though probably with some toing and froing on the way up.

Hedging is part of the cash management discipline ((CMD))

The community of Dual Mind Research practices CMD which essentially concentrates on cash as the risk control mechanism. Judicious use of hedging, and a long/short strategy, in general, is also about risk control. Hedging can be looked at as inverse cash. Hedging is a way to protect against undue anxiety and fear. Heightened emotions will harm your performance, whether you are a buy-and-hold investor or a fast money trader. When fear is rampant it can scare long-term investors out of their investments too. Back in October, we broke under 3600, is that level possible now? Or is that the low for the next 6 months? Many market commentators, technicians, and fundamentalists think that not only could we touch back to this level we could break under it.

My trades

I mostly added industrial names – I added Commercial Metals ( CMC ), Terex ( TEX ), and Manitowoc ( MTW ). Also with this talk about lending being more scarce, I thought Amex ( AXP ) which does lend to small businesses and is also associated with consumer experiences. Could be interesting. I also added SOXL because chips are everywhere, and with Micron ( MU ) seeming to improve, I think that is a sign for better chip consumption. Most everyone commenting on the current rally is focusing mostly on big-cap tech stocks. I believe that the rally if it is going to sustain itself, will spread out to other areas of growth. A very logical place to look is smaller tech names. Anyway, what I was getting at is that it is time to start picking some winners in smaller tech names. I think it is only natural that once this rally is accepted smaller cap tech along with industrial machinery and construction equipment will shine and also oil related names as well.

Well, that oughta hold ya for another week. Good luck investors large and small…

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