Still Sunday evening in the United States, Asian markets had opened. China, toward the top of resistance on a descending wedge, showed signs of rolling over. European markets later opened and reacted similarly. Emerging markets chopped up and down in anticipation of the US market, which opened in a state of intense anticipation for Tuesday's economic prints. Monday the 12th of December made for an interesting day around the world.
If the US market is a barometer for the world market, and the S&P 500 index is the best index to track US stock performance, then that is our best bet at understanding the direction things will go. $SPX closed right around the 3,950 level on Friday the 9th. As an options trader, my spread for the week was 3,800 - 4,100. I bought puts at 3,800 and calls at 4,100 with an expiry date of December 16. With economic prints coming out on Tuesday the 13th, and an FOMC meeting on Wednesday the 14th, my strategy was to scalp some 10-20% swings in either direction. Getting much fancier beyond this simple strategy did not seem wise. Or in other words, markets are a game of probabilities, and nothing is guaranteed. More on this in a moment.
One thing did seem to be guaranteed, though. It has been over a year now since we have had "good" economic prints. (Good is of course a relative term in this context.) Market consensus was that inflation numbers would come in at 7.3% YoY, and this would mark significant progress toward bringing inflation down toward target levels. If so, the narrative was quite straightforward: at 7.2 - 7.4%, we rally 2-3%. 7.0-7.2% and we rally up to 4-5%. This is from JPMorgan's trading desk. Could this be a cheeky form of market manipulation? Sure, anything is possible. Money managers, hedge funds, investment banking, and institutional money as a whole -- it is their job to have an edge, right? In any event, Tuesday comes, and the CPI print is as follows (see below):
There is a lot to dissect here, but let's just focus on the key number: 7.1% YoY. Market sentiment is extremely bullish on this print. That Tuesday the 13th, $SPX reached my call target at 4,100. Up several hundred percent, I sold those option contracts. I did this for two primary reasons. Firstly, it is never a good idea to get greedy during a categorical bear market. Secondly, and more glaringly obvious, sentiment had become far too bullish.
I won't lie to you, folks. I was guilty of this too. I tweeted (follow me: @SokolCapital) this photo (to the right) before the market opened that day. Wall Street city slickers would be rolling up to work that day like literal bulls on parade. While the good economic print was absolutely brilliant news, could 7.1% core price inflation with ever increasing Fed Funds rate continuously increasing? In the grand scheme of things, of course not. Moreover, macroeconomic issues loom large, such as sovereign debt crises in dollar denominated debt and not to mention unresolved geopolitical tensions. So my thought process was fairly straightforward, I'll sell this call option and enjoy my profit. If the market does go to the moon, fair enough! One excellent trait to develop as a market participant is "JOMO," the joy of missing out. Be happy for others when their trades do well!
The above chart tracks the S&P 500 on the weekly timeframe dating back to February 2020. You can see the drop in March 2020 (Covid-19, the "black swan" effect), the move toward all time highs due to incredible amounts of stimulus, and the market top in November 2021. Since then, we have been in a descending wedge that is bumping into prototypical support and resistance levels. For a brief moment, with the release of the CPI numbers looking better than expected, we jumped out of that descending wedge. Perhaps it was Jerome Powell's speech on Wednesday, perhaps it was the self-fulfilling prophecy of TA, perhaps it was market manipulation, perhaps it was all this plus various observable underlying market conditions. I will go into this in a video released in the next day or two. For now, take a look at this chart that tracks market sentiment, borrowed from Flame University (India).
While we are in some combination of both, the "top signs" are beginning to fade away, and cyclically, we are therefore moving closer in line with the "bottom signs." Why is this important? For one very critical reason: breaking out of that descending wedge will require something far more dramatic than a 7.1% CPI print. The great irony of all of this is that I, the one that posted a photo of "bulls on parade" on Tuesday morning before the market opened, ended up very nearly in the money on my 3,800 put as well. The way this market has chopped for as long as it has, all technical analysis, charting, researching conditions, historical comparisons, so on and so forth, I was smart enough to know one thing on the 13th of December: I did not know what where the market would go next. By Friday the16th, $SPX was at $3,810, just a smidge over my put option. Woudn't ya know it? One option was my best guess, the other a hedge. In the same week, both hit. It begs the question: what on God's green earth is going to happen next?
We must stick hold with conviction that underlying conditions dictate probabilistic outcomes. Right now,"The US Treasury Yield Curve is currently inverted, meaning short term interest rates are moving up, closer to (or higher than) long term rates. This unusual occurrence, called a yield curve inversion, has historically been a very reliable indicator of an upcoming economic recession. Since World War II every yield curve inversion has been followed by a recession in the following 6-18 months, and recessions are naturally correlated with decreased stock market returns."* Given that the S&P 500 is down 20% year to date, many would say that we are already in a recession. If so, hopefully unemployment does not spike, and hopefully there will be a soft landing. Maybe we are closer to that soft landing than many realize.
"Unpopular opinion: The Fed is done hiking rates... They just don't know it yet. The bond market, however, does." - From Dr. Jeff Ross, @VailshireCap on Twitter.
If short term treasury yields continue to roll over, the Fed pauses its rate hiking, and more economic prints come in under forecast sooner than expected, then that soft landing will be a temporary pitstop. And then? A launch pad. But if last week - not to mention this entire year of madness in 2022 - has taught us anything, it is to take things one day at a time.
Follow me on Twitter: @SokolCapital
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