TWLO - Market Should Retreat 10% To 15% By Mid-March Probably Sooner

2023-12-04 04:16:27 ET

Summary

• Stocks are expected to continue rallying into year-end due to factors such as strong earnings growth and talk of aggressive interest rate cuts.
• The Russell 2000 index is rising, indicating that the rally is spreading out, and sectors like biotech are strengthening as well.
• However, there are concerns of euphoria setting in and a potential 10% correction in 2024, so investors should consider risk before reward.

Everyone is expecting stocks to rally into year-end, why can’t that continue?

Sure it can rally further there are several reasons why the rally will continue into the year-end. As long as there is no new news to introduce instability in the economy such as an unexpected spike in inflation, we should see the indexes gaining. The market has been aggressively marking down interest rates, and moving the timetable for rate cuts sooner. This past Thursday Investors foresee Jay Powell lowering rates by March, The Federal funds futures market has priced in about a 45% chance of a rate cut at the March 19-20, 2024 meeting, rising to about a 75% probability at the April 30 to May 1 meeting, according to the CME FedWatch Tool. With this narrative, there is a powerful motivation to run back into stocks before the year ends. Much has been made of hedge funds, and fund managers being improperly positioned against this rally. This buying pressure lasts only so long, now the latecomers who held out the longest are rushing in, and that should continue into January. The rally is widening the Russell 2000 having hit a peak for the year at just over 2000 in August before falling to 1650 at the end of October, now the Russell is running back up just this Friday up almost 3% to 1860. Check out the 6-month chart from CNBC.

I am pointing out the Russell for 2 reasons, it is the most sensitive to interest rates, and being it is the small-cap index, it is a confirmation that the rally is spreading out. Many aside from the Russell sectors that were left for dead are strengthening. For example, the SPDR S&P Biotech ETF (XBI), check out the 6-month chart.

Biotech is another poster-child of sensitivity to interest rates. Most developing biotechs rely on secondary equity or bond offerings. Even if they are generating cash flow, their profits are out to the future and again are dependent on rates. As rates have been falling, the 10-Y treasury with a 77 basis point drop in rates since October, unprofitable stocks like biotech have been going up.

Nothing I’ve said so far has been revelatory

Let’s sum it all up. Long-term Interest rates have dropped hard, even in the face of record US Bond sales. Such is the confidence that the Fed not only stopped raising, that it will cut rates very soon. Even as Powell himself just this past Friday pushed back on lowering rates anytime soon, it is too early to declare victory against inflation. Powell on Friday says: Still, more progress is needed, Powell said. He added, "It would be premature to conclude with confidence" that the Fed has raised its benchmark interest rate high enough to fully defeat inflation. Let’s also note that the Fed raised its key rate 11 times from near zero — to about 5.4%, the highest level in 22 years. Yet, the S&P 500 is starting to turn in profit growth of 4% for Q3 so far with 80% having reported. So honestly it is just not about lowering rates but also strong profits even as inflation rates are improving no wonder the S&P 500 turned in the best month of gains since July up at 8.92% and the Nasdaq-100 up 11%, the best performance since July as well.

So this is all good, why the dark headline?

I am just sharing my judgment but having seen this movie before, euphoria is beginning to set in. The rally is widening, which is honestly healthy for the stock market. When it first occurs, I would be careful to tread too aggressively in names that have recently gone on fire. Even in growth stocks in the tech space, many names that were growing revenue quickly all along but weren’t prioritizing earnings, have delighted market participants and got amply rewarded. I am talking about names like Twilio ( TWLO ) closing on Friday up 37.13%, UiPath ( PATH ) up 26%, Snowflake ( SNOW ) shot up as high as 10% on Thursday, Zscaler ( ZS ) jumped as high as 8% on their earnings last week. Again, these gains were all in one week just this last week. This is not intended as a comprehensive list, just illustrating that we are moving into the euphoric phase. The funny thing about how this works is that the rise in stocks confirms the bullish narrative and then it becomes self-reinforcing. Soon, any earnings report that is positive will have day traders and new investors who don’t know any better rushing in as well. Okay, here is the punchline, as the new year gets started Powell will push back harder on lowering rates any time soon. Also, right now, the market is loving the weaker macroeconomic numbers, this Friday we will get the unemployment number I suspect it will have a 4%-handle on it. And as the mood in the market is so bullish it will be ignored. What happens when January numbers come in and that unemployment number is now over 4.5%? Will the mood be different? Mind you by this time, anyone who wanted to buy into this rally has probably done so by now. I can easily see a 10% correction coming, in fact over the last 20 years, a decline of at least 10% occurred in 10 out of 20 years, or 50% of the time, with an average pullback of 15%. And in two additional years, the decline was just short of 10%. So let’s say a 70% chance of nearly 10% or more each year.

Think about risk right now before reward.

Active investors like us are always thinking about the upside, and that is fine in a rally like this. However, if you take this year of 2023 in isolation, we have had a pretty fantastic run and this bull might get tired of running next year. So, if you want to get on the long side please do so nimbly. I am urging my investment group to start setting aside cash and start setting up some general hedges. I think 2024 will be a consolidation year and not at all a bear market. After we take a dip here, we will likely trade between 4600 and 4800 and perhaps have a new high late in the year. So that means being very nimble if you want to trade. If you want to invest wait for the sell-off, if you read my articles, you know I always lament that I am early. So I am thinking the end of January to mid-February should be about right, that also means that the sell-off happening in March is likely.

If you like to pick stocks, start thinking about stocks that can fall. Here are some of my downside trades

If the market continues to run up, at some point the level will be unsustainable. In that scenario building up some hedges is prudent. It is also costly as time wears on. So you have to be spot on, on your timing. I’m holding off on the hedging until perhaps mid-January. Except for the VIX, the VIX is trading in the 12s which is just too complacent. Instead, look for stocks that a volatile but seem to have been capped on going higher. One stock that I have been very successful on the downside using Puts is Tesla (TSLA). This week when it reached above 250, I bought some Put contracts out to December 29, at the 250 strike and I closed it out at 232. This week I will likely do it again but this time I will try to get a contract between 240 to 245. I was also in Puts on Disney ( DIS ) as Eiger the CEO was dueling with Trian Partners founder Nelson Peltz who wants a seat on the board. I think DIS is over-extended right now, I didn’t want to hold it over the weekend so I closed it out up only 14% profit. TSLA was 80% profit, I generally look for profits over 40% if they happen quickly. I know I must sound greedy but the way I trade options is I don’t sit with a losing position in options. I therefore take a lot of losses, once I find a winning position I tend to want to take as big a profit as is prudent. This week, I am going to start building general hedges just to add some protection of some nice profits in this 4th quarter. I will target the Nasdaq-100 ETF ( QQQ ) using Puts, or the triple-levered ETF (SQQQ). General hedges have never been more convenient. As far as the long side I did purchase some Uber Technologies ( UBER ) Calls at the 60 strike just before the close. There were rumors subsequently reported by Bloomberg that UBER would be included in the S&P500. This turned out to be correct, it was a precipitous move that I instantly regretted. Then, thinking it through a bit further, if I was going to take a flyer, this is the best time to do it. Even if it didn’t happen my downside was a few points and the likelihood of the market rally continuing into year-end will push up the share price of UBER anyway. Then come the turn of this year into 2024 please don’t do stuff like this, set aside cash, don’t get too risky, pair your long trades with Put opinions, and begin to build hedges on the Nasdaq-100 and the Russell for that matter

Enjoy the rally while it lasts!

For further details see: