The year started in the most boring way possible, keeping us all in a tight range in what seemed the unbreakable wall at 3850 until it violently broke to the upside. As of January 27th, the S&P 500 was at the same level it was back in August when the famous Jackson Hole speech was delivered, which is ironic enough. Although there was some improvement in fundamentals, this move was largely driven by technical factors and, eventually, by the fear of missing out on returns and short covering. Let’s go through all of them one by one.
First of all, the overall liquidity in the system increased for a variety of factors, the biggest one of them being the Treasury draining from the TGA as the debt ceiling discussion made them unable to issue bills. Then, we had all the inflows from delusional retail traders that continue to DCA into their underwater holdings, and from CTAs being long. When we broke the channel, many shorted too soon, calls started to pile in, and we continued to grind up slowly, until short covering became explosive.
Something that gets little attention in my opinion is how low the real volume has been this month during the sessions, as more than 70% of it was just 0DTE options and, hence, market markers hedging their exposure. This factor led many names to rip higher violently on no news and without any kind of reasoning behind, like what we saw with Nvidia, and made the entire market look like it’s stronger than ever. Many bearish-leaning traders threw the towel, some of them flipped long, some of them blew up. I’ve been on the short-side of the market for the entire move, although hedged well, and I can assure you it’s been exhausting to see the market just slowly grind up higher as if it wasn’t allowed to go down.
Speaking of 0DTEs, it’s important to note that those are not used just by retail gamblers: indeed, the biggest volume in these instruments come from institutional players. The reason behind it is that, since they expire the same day, due to a regulatory loophole they fail the margin check. As you can well imagine, the magnitude of risk that this phenomenon poses to the system is incredibly high, and will likely lead to a credit crisis the very moment volatility gets higher unexpectedly and market makers fail to hedge properly. In all honesty, I think that in a few years time we will look back at 0DTEs with the same perplexity we now have thinking about the CDOs squared.
Looking at the fundamentals, PPI, CPI and PCE showed further improvements, which helped the pivot narrative to gain momentum once again. By doing so, however, the dollar weakened once more and commodities started to rally, which is nothing but negative inflation-wise: indeed, just by seeing this rally we should all expect a hot CPI in February, at least on a MoM basis. Furthermore, because of the lower dollar, lower yields, and stocks rallying, financial conditions continued to loosen up so much that, now, we’re back at the same place we were in February 2022. Ironically enough, at the time the Fed hadn’t even started hiking rates: in other words, it’s almost like the Fed did absolutely nothing for the entire past year. This doesn’t mean that the past effects of the hikes on the economy are now reversed, but the outlook for the near term is optimistic, which is yet another factor to keep in mind when thinking inflation has peaked.
We have to keep in mind, however, that although inflation is undoubtedly coming down, it’s still way higher than the 2% target, and the Fed has said multiple times it prefers to tighten too much than risking the inflation resurgence like it happened in the 70s.
Moving to the labor market, it continues to hold up strongly, with jobless claims resting at historical lows and unemployment being stable at around 3.7%. The good news for bulls is that wage growth has decelerated. The bad news for bulls is that the largest employer in the United States, Walmart, just announced it will raise wages to its employees to keep up with inflation. As I’ve already said in this article, the second wave of inflation will likely come from wage adjustments, which is the reason why the Fed is so focused on the tight labor market.
The market can be a tricky thing to navigate, and as the saying goes, “the market can stay irrational longer than you can stay solvent”. The current market is completely ignoring every kind of bad news, and get bid up on a narrative which has little to zero chances of play out in real life. Furthermore, the narrative driving this move is contradictory. Indeed, the market is currently pricing around 200bps of rate cuts this year, but it’s also pricing this FOMC’s hike to be the last of the year and the recession to be completely avoided. However, this doesn’t make any sense: the Fed won’t cut rates unless some kind of crisis happens, and if that’s the case it’s not bullish at all. As I wrote on Twitter, if the economy goes well, there is no reason to cut.
But the market doesn’t see it this way at all. According to FFR futures, this FOMC will raise rates by 25bps with an absolute certainty, although in my opinion that would be interpreted by the market as a pivot and will leave the Fed unable to talk the markets out of their dreams anymore. The best choice to set the tone and keep financial conditions tight would be to raise the interest rates by 50bps, have a hawkish speech in the conference, and most importantly increase the rate of QT from $95bn/mo to $120-150bn/mo. A speech like the Jackson Hole’s one, possibly explicitly pointing out to no cuts this year, would do its job. I’m keeping my bear stance until the presser, and I’m ready to close all the positions if the Fed actually chickens out by choosing to do just 25bps and a hawkish speech: the market doesn’t really care about words, we saw that on November 30th already.
The rally has been so violent that many started to question whether it’s still a bear market, or we just missed the bottom back in October. To be fair, I thought about this myself, but fundamentals don’t support the start of a bull market: despite the market looking away from them, earnings have been pretty disappointing so far, and guidances were all pointing lower. To further prove that this is just a bear market rally rather than the start of a new bull market, what’s being pumped the most is meme stocks and overcrowded shorts. Just to take a few examples, as of January 27th, Bitcoin is up 39% year-to-date, Tesla 50%, Nvidia 37%, Coinbase 68%, Gamestop 22%, AMC 37%. These are all considered meme stocks, so it’s not surprising that the garbage-collector ETF ARKK is up bigly for the year. The most incredible example of peak stupidity has been Buzzfeed, which is up 417% year-to-date after announcing it will use ChatGPT to help the writing of articles.
Of course, as the rally gets us higher, we’re back to seeing the crypto guys telling everybody how smart they are, and the improvised stockpickers creating odd narratives based on pure hope to justify the market moves. To me, the sentiment looks like what it was in early 2021, where you were buying something just because it had a funny name, and still making money off it. The problem with all of this is that, unless the Fed decides to actually change its stance and delaying the economic pain further ahead, the higher we go now, the more violent will be the selloff once reality kicks back in.
Positions
The structure of my portfolio is getting more complex as the time goes by, and it’s very difficult to summarize in a single number the percentage exposure I have to any single name. This is due to a multitude of factors, including the usage of both shares and options to create positions, and the presence of short selling. Therefore, I’ll just divide my positions into longs and shorts:
- Longs: UUP
- Shorts: NVDA, AAPL, SPY, FXE
I’m in cash at roughly 74%, in dollars. I’m eyeing NEE, FPI, and MA for longs at around 72, 12, and 285 respectively. Furthermore, I also plan to get back into GBP/USD short and MOS long as soon as the FOMC ends.