February started off with the FOMC, which I expected it would have delivered 50bps and hawkish remarks: I couldn’t be more wrong. In a very disappointing turn of events, not only the hike was a mere 25bps, but the presser showed us the softest version of Powell we’ve seen in a long time. Indeed, during the presser, not only did Powell deny that financial conditions loosened, which is demonstrably false, but he spent most of his words in celebrating victory in the fight against inflation. Having no dot-plot, Powell’s speech was way more important than usual, and it was perfectly clear from market movements: indices squeezed hard. The squeeze ended the day after reaching the high of 4195 on the S&P500, giving the name the title of “bear capitulation day”.
During February’s FOMC, it has been made a huge policy mistake. First, the Chairman lied on the financial conditions, which loosened so much that the entire hiking process has been completely offset. Secondly, hiking by 25bps instead of 50bps on the fear of surprising the markets signaled a shift towards a less aggressive policy, which given the extreme euphoria we had all around was no different from announcing a pause or a pivot. Third, it was unwise to victory lap on inflation fight telling everyone about disinflation (he said the word 50+ times), just before receiving extremely hot CPI and PPI reports. The Fed rightfully whined about how the market doesn’t take them seriously anymore, but it comes to no surprise if this is their behavior.
Although I may be delusional, I think the Fed will try to fix the error on the next FOMC, and these are the only two ways to do it in my opinion: 25bps, but QT increases to $120bn/month at least, or 50bps. On top of that, I’d expect the dot-plot to show a terminal FFR around 5.7-6%, and Powell’s speech to be hawkish. The problem with QT is that despite it being a reality already, between the TGA drain and the liquidity injections by foreign central banks (i.e. BoJ and PBoC), it has been completely offset, and it’s almost like QE stealthily came back. Inflation is clearly rising, the labor market shows no signs of weakness yet, and equities are more euphoric than they were back in the 2021 QE-infinity bubble: it’s pretty obvious that the monetary policy is still far from being actually restrictive. Having Fed members speak every other day and continuously contradicting themselves doesn’t help.
The day after the FOMC we had the earnings of Apple, Amazon, and Alphabet: that week was loaded with events! Of course, the most important one among them was Apple, and their results were simply terrible: EPS was $1.88, missing the estimate of $1.94, and revenues were $117.15B, missing the consensus of $120.69B. No matter how much you wanted to spin their results, there was no way to make it seem like a good report. However, market makers were clearly unhedged for such a miss, and despite an initial drop, shares recovered very rapidly and continued to rally even during the RTH session. The day after one of its worse reports in a very long time, Apple closed at +3.71%, fueled by numerous 0DTE calls that hit the tape just in time. Given how much Apple weights in the S&P500, this “incredible” recovery fueled a rally in the entire index, propping up the index and giving us the “bear capitulation day”.
However, the market apparently realized that it made no sense to price in disinflation, growth and cuts at the same time, and by February 6th the implied terminal FFR curve was pricing no more cuts until December (tweet). A few days after, there were no cuts priced in for the entire 2023, although as of the moment of writing there are still a few priced for next year.
After the capitulation day, indices struggled to keep the gains and rolled over roughly the entire month. However, except for maybe four sessions, every red day has been accompanied by daily chop or big intraday rallies. The latter, mainly fueled by 0DTE calls hitting the tape with surprisingly accurate timing. In other words, despite the decline in the S&P500 by 5.3% in 26 days, it never felt like a selloff, but rather like just a small correction. The sentiment remained very bullish as well, and the volatility continued to get crushed as a result.
The idea that this decline was particularly bullish was confirmed during the first two days of March, during which, after rejecting simultaneously both the 200dma and the bear market trendline thanks to a suspiciously unexpected and well-timed dovish remark by a non-voter Fed member, the S&P500 rallied 3% from the lows in just two sessions. More than a week of losses was offset by this pump.
To further highlight how the index decline seemed too bullish for it to be another leg down, the clear winner of 2023, Nvidia, didn’t flinch until February 14th, the day we got the hotter-than-expected CPI. You may argue it made no sense for the market to rally on such data, but given the above paragraphs there have been plenty of things not making any rational sense already, so it’s not to be surprised. After that day, the unstoppable Nvidia finally started to feel the gravity, declining almost 10% in seven sessions. Then we got to the “make it or break it moment”: the earnings.
All the stars were aligned for their numbers to be bad, as we got signs from Intel, Apple, Samsung, TSMC, Microsoft, AMD, Micron, and a few other companies too already. However, although numbers were indeed bad, shares moved unexpectedly higher. At first, we all thought that the firm was scared to report, as the numbers were published with great delay, and we ironically risked having the call earlier than the numbers. Then, the management team in a very smart way pulled off the snake oil salesman trick: they said the word “AI” not once, not twice, but 75 times, increasing the value of the stock by an average of roughly $640M each time.
Looking at the chart, you may wonder how did a +14% jump hold with declining revenues, declining free cash flows, and results that barely beat estimates that were already lowered several times: I’m amazed as well. A few days later, insiders sold even more shares, and the company announced it was going to make a $10B mixed shelf-offering, basically confirming that even the management thinks the current price is beyond insane. And yet, the market continued to bid it up. I’ve stopped trying to rationalize it, although I’ll say one thing: buying it here, at 133+ P/E in a rising rate environment, exposes you to little if any upside, and tons of downside. According to my DCF, we would have a $100 target in an optimistic scenario and roughly $85 in a realistic scenario. You do you, but that’s not the kind of risk/reward you want to have when buying shares.
All in all, my take is that equities are floating on very thin air, and the longer we stay this high, the more fragile the market becomes. If the J.P. Morgan collar works as it did the last two quarters, we should close on March 31st a little above $3,600, so time will tell. However, it’s clear for a selloff to happen on the index level, we’ll need something more than just economic data: the market shrugged them all off already. The catalyst may be a geopolitical event, such as increased tensions between the West and Russia, or between China and Taiwan, or between Israel and Iran. The catalyst may also be just the Fed itself, that may deliver an actual hawkish speech on the next FOMC addressing directly the market irrational exuberance, along with 50bps hike and a dot-plot showing a higher terminal FFR.
Moving to Europe, it continues to show strength. The ECB hiked by 50bps as expected, and guided to another 50bps hike in March. Similarly to the Fed, the Central Bank underlined the fact they want to keep interest rates at restrictive levels, and that they’ll be data-dependent regarding how to move in the future. However, despite the terminal rate being priced at around 4% (it’s currently 2.5%), it’s debatable how long the ECB can hike before experiencing economic pain. Indeed, Europe has a structural limit for how high the interest rates can be raised, mainly due to the dependency on low financing rates both for companies (too many zombie companies in Europe), individuals (big share of variable rate loans in many eurozone countries), and countries themselves (high level of public debt). Each hike is a step closer to either experiencing a bad recession, or a sovereign debt crisis. As inflation is clearly still in an uptrend and shows no signs of deceleration, further hikes are needed, although the market is not yet considering their consequences.
Furthermore, since the structural limit for the United States is way higher than Europe’s, it’s unlikely that the ECB will be able to keep up with the Fed, which in turns will be reflected as downward pressure on the EUR/USD pair. However, it looks like Europe is experiencing a great amount of inflows from foreign investors, mainly Americans, that are looking for opportunities abroad: these inflows have been front-run on the FX pair, and resulted in many European indices showing high strength. Although that’s not my main case, if these inflows continue, we may see a situation in which the value of the Euro declines while European indices continue to rally.
Positions
As I’ve anticipated in January’s portfolio update and in this tweet, I was eyeing NextEra Energy (NEE) and Farmland Partners (FPI) for long-term investment entries. Over the course of this month, they both declined enough for my orders to get filled at $71 (tweet) and $11.87 (tweet) respectively. I’ve also followed the plan of getting back in Mosaic as soon as the FOMC was out of the picture, and bought a few Alphabet shares after the Lambda-related crash. So far so good.
Current positions:
- Longs: NEE, FPI, MOS, GOOGL, UUP
- Shorts: NVDA, AAPL, FXE, FEZ, SPY
I’m in cash at roughly 80%, in dollars.
Acknowledgments
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