Kirk Spano's Q4 2021 Outlook & Game Plan

Summary

• Inflation is transitory, but the worst might be right in front of us for H1 2022, stagflation.
• The Fed taper is very likely to cause stock and bond market reactions that are rather severe given heavy retail participation in the markets.
• The high levels of margin and call option in the market, and now Millennials having learned how to bet on a decline, means a correction could be fast and steep.
• The good news is that once the downward momentum has ceased, it will be a Great "Re-do" opportunity to buy the best performers with the best business outlooks.
• I intend to be buy a few ETFs that have performed well the past 5 years when they are on the cheap.
• This idea was discussed in more depth with members of my private investing community, Margin of Safety Investing. Learn More »

gremlin/E+ via Getty Images

My quarterly outlook and game plan is a simplified look at what the stock market environment and what I am planning to do about it. As with anything, we have to remain nimble and consider multiple scenarios to be ready for whatever comes our way.

Currently, I am holding high cash balances in most accounts, however, what we own has the ability to beat the markets handily in a continued up cycle. In the past quarter we took advantage of opportunities to buy beaten up SMID caps and communications stocks.

I would expect the next correction to be an opportunity to buy large caps, in particular, the Invesco QQQ (QQQ) ETF which is composed of some of the strongest and most cash rich companies in America.

The Federal Reserve Taper

The Financial Crisis was the dawning of the Age of QE, that is, quantitative easing, or as it is incorrectly, but sort of rightly referred to as, money printing.

Each time the economy and stock market started to weaken in the past 13 years, the Federal Reserve has come to the rescue and printed money. The result has been a stock market rally each time. You can see the correlation in this chart:

While there is certainly some minor time lags, those who poo-poo the idea of this incredibly high correlation in favor of some trading system with its own language are being immature and talking their own interests.

Any denial of the correlation of Fed actions to the economy, bond market and stock market is ignorant at best and disingenuous at worst.

The stock market is incredibly likely to take a hit when the Fed finally tapers its quantitative easing. Certain stocks will be hit worse. Among them will be what I call the Zombies of the S&P 500 (SPY) (VOO).

The Zombies are companies that are high debt, low or no growth, capital intensive and are fighting secular trends, such as, the shift away from fossil fuels or towards digitization.

I have found at least 100 companies out of 500 on the S&P 500 that qualify for my Zombie category and there is probably north of 150.

Among the walking dead are many dividend paying companies that certainly can't cover their dividends and debt payments in an environment with more expensive financing. Capital intensive companies on the wrong side of innovation beware.

When the correction hits, it will set off a correlated correction within the S&P 500 because fund holders at some point will panic. When that happens, the funds are forced to sell down stocks proportionally to their market cap.

I expect the S&P 500 to head towards 3500 and possibly around 3000. An Armageddon scenario also exists in which a spiral down to 2016 price levels occurs. The only thing I can see triggering that is a severe meltdown or supply chain disruption (potentially deliberate) in China.

Once the correction is over in large caps, there will be excellent buying opportunities in the best companies with the best relative stock performance in the past 5 years.

Focus on winners, on the right side of secular trends, with great cash positions and ample growth. This isn't just restricted to growth stocks, dividend paying stocks need the underlying business strength in what is going to be another decade of even more significant economic transition.

And, remember, don't fight the Fed.

The Price Of Oil Will Fall

I might be a quarter early here, but OPEC has a vested interest in having a Goldilocks price of oil. Too high and it will spur on a more rapid transition away from the black gold. Too low and they won't maximize their profits in this window of the end of the oil age (which will take a couple decades to halve demand).

So, we should expect the price of oil to fall in coming months as OPEC prevents more. We have already been given the first signs that OPEC will release more oil into the market.

What will the price of oil average in 2022, around $70/barrel seems about right. It could obviously head lower on something horrific with Covid variants or higher on conflict in the Middle East.

As we saw during the Trump Presidency, low oil played a major role in supporting the economy - along with low taxes and massive deficit spending. We should expect oil to be somewhat supportive again, though we are not sure how fiscal policy will look.

Clean Energy will remain a big story regardless of what happens with oil. It is just a matter of time before EVs cut oil demand dramatically. I anticipate peak oil demand before 2030 and oil demand to fall in the 2030s. This is in line with several oil majors recent forecasts.

Supply Chains Will Continue Moving

Clogged up supply chains is perhaps the most important short-term cause of inflation. Many resources are simply not getting to where they need to be. Products, if they have been made at all, are also stuck, often at sea.

Cheap money makes it easier for corporations to move supply chains, so I wouldn't expect the Fed to get too tight. In fact, this is my pinned tweet until proven wrong:

Fed Won't Finish

https://twitter.com/KirkSpano

To summarize, major supply chain moves are happening for 2 core reasons:

1. Too reduce dependence on an unpredictable China (or pick your adjective).
2. Machine learning and lower global wage disparities are making it easier to move supply chains closer to customers and resources.

The United States of course has a lot of customers who spend. And, Canada and Mexico are no slouches. In addition, the resources for almost everything can be found on North America.

Think through that Canadian Pacific (CP) and Kansas City Southern (KSU) merger again real quick. What was Kansas City Southern's main asset? Routes form the U.S. to Mexico. Canadian Pacific just created a train line from as far north to as far south as the new NAFTA allows.

The move of supply chains won't be quick. Semiconductors for instance, the brains of technology, drive the world. It's going to take about two years for Intel (INTC) and Taiwan Semiconductor (TSM) to get up fabrication up and running in America. Til then, tight prices.

As supply chains move though, and quite a bit will have happened by 2023, inflation could run a little warm. But, the idea that we are seeing hyper inflation is just not within the definition. What people need to do, those who can anyway, is use the reshoring of jobs to find higher pay. I know easier said than done.

The Reopening Economic Surge Is Flattening

While there was a brief "V" shaped recovery in the economy, it has pulled back a bit and is now on a very normal trend. Hardly something to bid up all stocks over.

GDP Normalization

FRED

Investment Valuations

And yet, a normal GDP picture and Fed tightening are coming at a time when large cap stocks are exceptionally expensive.

This could mean a more dramatic correction.

Market Leverage

High stock market leverage could also mean a dramatic correction.

Here, we can see that as leverage fell slightly in ETF trading, the stock market also came down a bit.

More broadly, record leverage is driving record stock market levels. When have we heard that before?

The Millennials Are The Market Now

While I will save proving this for another piece, it is suffice to say that Millennials are the marginal money in the stock market. They are driving the trading, favoring what they want to favor with little to no regard for Grandpa's stocks.

To the extent they have a weird hobby, they like to blow up hedge funds that short stocks they like, such as AMC (AMC) which has little redeeming financial value, but, they show cool movies, so that's good enough.

What's important to understand is that Millennials won't put money into something, then you shouldn't either. Ok Boomer?

By the way, as I mentioned might happen in an article a year ago - Will Young Traders Flip The Option Switch To Cause A Crash? (I highly suggest you read that one) - the Millennials have learned how to bet the downside of the market too. See their recent put activity:

Small Trader Put Volume

SentimenTrader

An interesting study came out recently. It concluded that retired men were the most likely to panic sell. Might I suggest doing it now at higher prices so you can buy back later at lower prices. And remember, last one to the door shouldn't bother leaving.

Other Wall Of Worry Stuff

Congress is dilly dallying around with important stuff. It's like they were politicians or something.

More interesting is some of the massive put and call trades made by funds, in particular by a J.P. Morgan hedged equity fund. I won't try to explain it all, but it causing some choppy trading and could cause the S&P 500 to gravitate lower towards year-end. Here's somebody else's thread on it on Twitter that makes is fairly easy to follow.

I wonder if China will use supply chains as leverage to cut a Taiwan deal?

Aliens.

Investment Game Plan

Most of the super cash rich companies in America are found within the Nasdaq QQQ (QQQ) ETF. Companies such as Microsoft (MSFT), Alphabet/Google (GOOG), Apple (AAPL) and Facebook (FB) are among the richest several companies in America. Upon a correlated correction of large caps, I plan to buy this ETF in all accounts.

Berkshire Hathaway (BRK.B) is among the richest companies in the S&P 500 and has wonderfully diversified business that gushes cash flow. I will buy Berkshire in all accounts or add to existing positions.

There are also several other ETFs that I like, among them Cathy Wood's Ark Innovation (ARKK) once it has a reasonable forward looking P/E again and the Invesco Clean Energy ETF (PBW) which is set to ride a massive secular trend as the entire energy system shifts for the next decade or two. Both have been big winners the past few years and I expect that to continue.

In addition, I will continue to add great companies at good prices where I can find them. Lately it has been SMID caps, but I can see dividend stocks becoming cheap again on a broader correction. Smart selection will be key. We want to be on the right side of secular trends, with companies that have great management and large total addressable markets.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of QQQ, PBW, BRK.B either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[panzer]

watch the russell 2000, as a key canary in a coal mine. the gov workers will deploy a billion here or there, in various ways and means, to keep up the major averages....buying futures, buying the major etfs........but as you can see, the middle class of the stock markets, the 2000, is evidently harder to keep up, being less concentrated in the Big 7 names. When it breaks its 1 year channel, you will see the markets begin a major step down, and it is getting there, inch by inch, step by step. The gov workers have all their pensions in the stock market, so in an age of trillion dollar leftist special interest group legislation and budgets, it is foolish to think they will not spend some billions here and there, to keep their money up. I know I knokw, they cannot do it forever. But they will try. They give away trillions to their voting groups yearly, so why wouldn't they take 1/500 of that, to keep their pensions all tidy and nice? If they are fixing national elections, which is now an existential fact (leftist love that college word, existential so I thought I would throw it in), fixing or attempting to fix public markets is child's play. In fact, they already have this vast circuit breaking system (and god knows what else) to keep markets up, in times of true price discovery (they call it a panic, lol...it is never a panic when stocks go crazy mania higher, only when they go lower, LOL). And entire system of criminalality, stolen government, and as anybody who has an ounce of sense knows, CIA has been fixing elections as an instrument of national policy for 70 years, examples too countless to list, so you know they authorrized this recent domestic one. But here they have their own pensions at stake, so they are gonna call their financial brethren to keep the markets up, do what can be done, for as long as can be done, and then, watch out below!

[Goomba69]

@panzer still shell shocked from WWII?

[panzer]

@Goomba69 wealthy from the stock market...

[Goomba69]

@panzer you must be very grateful to be on the gravy train of the fixed public markets.

[SeekingTruth]

Solar, Wind, EV, etc. do NOT have to increase by huge multiple amounts to make a real difference in our energy costs of oil and gas.

This is highly related to the concept of Marginal Utility, and we only need to offset what would otherwise be shortages in oil and gas to make a big difference.

So if the demand for oil and gas is increasing by 1% a year, we need to offset that by an equivalent amount of Wind, Solar, and EV production, (i.e. increase by at least that equivalent to 1%) and if we can increase alternatives by a per cent and a half (1.5%), then we can get ahead of the game and really reduce our dependency on oil and gas.

Remember, it is the "action at the Margin" that counts the most - very similar to the stock market one might say.

[blah64]

enjoyed your article, it will be exciting to find out how the 4th qtr plays out and going into the 1st of 2022.
i have been building position in brk/b since feb 2020 and will have to watch how the oil/gas story plays. have been in epd since 2012 and used to down 8-9 years just collect div. put it into brk/b and some financials.
glta

[rtrdengineer]

I like many points you discuss, but I disagree with oil and LNG. There are only so many windmills and solar farms that can be erected. Power outages in many places and rolling blackouts? No one has mentioned the windmill graveyards and solar panel life cycles. It also takes electric power to produce all this equipment and move it. Forcing utilities to shut down when the sun doesn't shine every day and the wind doesn't blow could be catastrophic. There needs to be an equilibrium of energy production, not just a political power grab of votes. No one can stop the political side, but I hope someone is planning for a future where energy is available. Extremes are dangerous as with government control.

[Dale Roberts]

It's OK, Fed says the economic growth is likely gone. 2.2% for Q3.

fred.stlouisfed.org/...

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2021 is 2.3 percent on October 1, down from 3.2 percent ...

The Fed does not have to worry about tapering or raising rates, the economy by itself can take care of any economic slowdown.

The only wildcard will be inflation of course.

My guess is that they will have to let it run hot it need be. They can't kill the stock market rally.

Help the rich, hurt the working poor will continue IMHO.

Dale

[Dale Roberts]

@Kirk Spano good post, I always enjoy your perspective. Hopefully retirees and near retirees have locked up some of their stimulus gifts (stock market gains).

I would suggest that traditional oil and gas might be a generational opportunity. And sure at some point those gains could be directed toward green ETFs. Maybe oil and gas has a good run for 5 or several years?

There is no viable green energy transition plan. It's mostly blah, blah, blah, remember. And unfortunately.

Underlying, the basket of companies in that green ETF loses a lot of money?

But sentiment and government support is on that side. Don't fight the free monies and regulation over time, perhaps.

I've been happy to trim some high flyers along the way. I have no problem adding to some U.S. stocks with decent value such as BRK.B (great stock market correction hedge with $140 billion in cash in good hands).

I agree, I'd go back into those names (my tech basket beats the QQQ) if we ever get a real correction again. If there is no correction, those profits fund semi retirement. Those profits work in concert with those ongoing higher prices and homemade dividends (sells for income).

And of course in Canada our stocks pay ridiculous growing dividends. The big banks are set to offer double digit dividend growth for a while when dividend and share buy back hold is lifted.

Happy to hedge inflation with energy and commodities, and our real estate.

Best of luck to all.

Dale

[sgt.red.blue.red]

There may be a selloff. But, you have to ask yourself, ‘where will these indices be in five years’? If you say higher, you’re correct. So, I’m not going to get all lathered up about some selloff. Retired (evil) white man. lol

[Dale Roberts]

@sgt.red.blue.red valuations say no real return for 10 years, for the stock market. Maybe you eke out a point or two, who knows?

The real earnings yield for the S&P 500 is currently negative.

Valuations matter over time.

I'd rather buy earnings. I've been trimming the expensive stuff (call it rebalancing if you like).

We might buy back some in the next real correction.

Dale

[sgt.red.blue.red]

@Dale Roberts If Warren Buffett sells out all of his equity holdings, I’ll be concerned.

[Kirk Spano]

@sgt.red.blue.red I think SPY has very limited upside this decade. 5000-6000 still late in the decade. Too many zombies dying slow deaths. QQQ, SMID caps, some EM and a handful of S&P stocks.

[E.D. Hart]

Howdy Kirk---thanks for the article, always entertaining, and informative. I have to respectfully disagree on oil---I see the natural gas price as pointing toward more power switching from gas to oil, as LNG is getting too expensive. I see a 6 month runway for that, perhaps $90 oil, but I digress.

Im gonna go out on a limb and say, based on your comments, that you poo-poh Elliot wave theory? I can't wrap my head around it when the logic of liquidity and QE is staring me in the face.

[Kirk Spano]

@E.D. Hart there’s validity to Elliott Wave because we keep panic buying & selling. BUT, it’s no better than RSI and monitoring divergences. AND, anyone who poo-poos fundamentals - which ALWAYS win out in the long run - isn’t doing folks any favors. I do my best to think about companies & industries like a C level exec or business owner. From there I use very basic technical analysis to aid in scaling in and scaling out in a pretty measured way. Fundamental analysis is the house, technical analysis is the door.

[SeekingTruth]

@Kirk Spano
RSI is very good, and its full interpretation is an art form.
Elliot Wave is anything that anyone wants to make it, and the varying explanations and interpretations are endless, and I accept it has some validity, but not enough for me, so it is in my third group.

And RSI alone is no where near enough so I support it with 12 other TI's (6 primary, 6 secondary), and another family of special indicators while recognizing where they overlap, and add little, but they all tell me something a little different in a slightly different perspective so they are worth it overall in total.

If you have a service that let's you overlay indicators visually that can be a big help when the right TI's are selected.
For instance, this is especially true (for me) when I overlay selected TI's with Balance of Power (BOP) , which I know that you like also.

Like you, I look at the full spectrum of conditions, and Tech Analysis is just a small part of it, but an important small part.

[DWS1644]

What happened to your call saying oil never going above 60$? IMO you are overestimating OPECs supply capacity. Saudi is probably maxed out at 10.5M-10.8M. Anything above that for a sustained period of time can potentially damage their reseviors.

[Dale Roberts]

@DWS1644 Many calls now have oil in the $80 to $100 range at some point in 2022. Supply and demand. The longer term story is greatly reduced CAPEX as oil and natural gas demand grows.

We are not getting the green transition thing right. If we get it really wrong energy crush turns into energy crisis.

Near term all of the cash glow is in traditional energy. The long term green story might take longer to play out than most think.

It's tough to throw money at a money-losing basket that has good growth potential.

I'm in with BATT for now.

Dale

[Kirk Spano]

@DWS1644 actually, I said oil would go to $80 in 3 articles, but realized it was capped ex-short term events because demand growth is about to be over. I said range bound oil & expect average price around $60.

[Kirk Spano]

@Dale Roberts new battery tech is so good, cheap and lacking REO that the next 3-5 years will see utilities transition to solar & wind even faster.

[Jlexus1953]

Don’t see interest rates rising before 2025. Too much inflation pressure

[Humble_Modesty]

That twitter thread was an interesting read. If I didn’t know better I would believe markets exists just so large institutions can charge their management fees at the expense of everyone else’s returns by introducing unnecessary volatility.

Dumb question…Could the “unnamed institution” referenced in the thread also be market makers? If so, wouldn’t they just be shifting money from investors in a fund within one division to another division within same institution? Or am I being too cynical? It’s not like I’ve been given any reason for cynicism over the years.

Aliens.

[Kirk Spano]

@Humble_Modesty JPM, GS, MS… ummm, how do I say this right, they’re all a little shifty.

[albertciampi]

So should old retired guys like me go to 100% cash? I’m at 21% cash now but have had a gut feeling for awhile that will not be enough. Also I need the other 79% earning income to pay the bills. What to do.

[mdfuller_OR]

@albertciampi great question to ask ... only you can answer
i can tell you what i've done (>60 retired, yet to claim social security) ... if you're interested send me a personal message.

[Kirk Spano]

@albertciampi I never rec 100% cash because we’re fallible. I think selling options is very smart using weekly RSI charts. Also, there’s always good stocks on discount. T, VIAC, CMCSA. Usually a few in some unfavored group.

[Dennis 1]

A lot in there to digest, interesting thought process. Thx