Get Ready For Rough Seas, Then Smoother Sailing Mid-Week; Also The Plan Of The Week
Summary
- The Market has yet to discount +3% interest on the 10-year.
- The market is also discounting the possibility of .75% rate rise.
- The highly elevated VIX of +30 is telling us that we should expect 1% to +2% swings every day.
- All this is going to be compacted into just 3 days. We could see the S&P 500 break 4000 this week.
- Don't let the sharp selling push you to panic and sell. I believe that Powell's tough talk and rate rise will bring clarity to the market and begin to rally again. Though, I can't say that this is THE rally.
- Looking for a helping hand in the market? Members of Dual Mind Research get exclusive ideas and guidance to navigate any climate. Learn More »
andrej67/iStock via Getty Images
The 3% Solution; Market Participants are still discounting 0.75% and a +3% 10-Year
I suspect that your weekend reading of financial media has already told you that Friday's close near the bottom was a terrible harbinger for this first week of May. If you think that it’s already in the cards that we are getting a ½ point rise in rates and not a 0.75% raise, think again. The stock market hates uncertainty, and since several Fed Presidents mooted the idea that 0.75% was on the table, as well as Jay Powell asserted several times that they will make their decision on the day of the FOMC conference. Also what is likely weighing on the market is what’s to come next month. As of at 9 am just this past Friday morning that according to the CME's FedWatch Tool, the market is pricing in with a 94.5% probability of a 75-basis point rate hike at the June FOMC meeting in addition to an expected 50-basis point rate hike at this week's FOMC meeting. So I bet you are thinking what is this guy talking about? CME says the 0.50% is baked in the cake. I still think it’s enough to at least keep downward momentum going that .75% is still a strong possibility for May. The truth is with all the momentum coming down on the indexes on Friday, sometimes momentum begins to move on its own accord. This market is just the sourest market I have experienced since 2008. This is not 2008, what it is, is a market that has been effectively jawed down by the Fed ever since the year started. I have dealt with the sentiment in these pages several times, but it’s not just the Fed, it is every self-appointed macro-economic expert shouting that the Fed is behind the curve. The narrative has been that we are either in a wage-price spiral or a consumer-induced spending mania that will require raising the rate so high Paul Volker would be pleased. Or the much-ballyhooed stagflation, which should be awarded unicorn status, it’s so rare yet it is talked about like it happens every day so it certainly will happen now. According to the latest AAII Survey, this is the widest difference in the bull to bear ratio in 30 years.
So what happened to make the last day of April a coda for the lousiest April since 2008? Add insult to injury, April is supposed to be the best month in the market. Well, some will point to the initial GDP for the first quarter that gave us the first negative month since the pandemic. The more level-headed analysts noted that the negative number was due to a distortion in the data. Also, the first publishing of GDP is notoriously unreliable. It might have been the straw on the proverbial camel’s back if anything. I maintain that the downward momentum was already there. For one the VIX has been near or over 30 the whole week. This is an unusual level to stay this high for so long. I think next week the VIX will reach for the high 30s as commentators do their best to play up the drama. From my vantage point, the chief motivator of negativity is the 10-year. This latest sell-off was due to the speed at which interest rates on the 10-year shot straight through 3.0%. The last time interest rates accelerated we had a very similar reaction. I am sure I mentioned recently that market movements tend to repeat albeit loosely. Not too long ago the 10-year was 1.3% then bounced quite rapidly over 1.78%, the market indexes withdrew with alacrity. I believe we are reliving this experience. The last time the market sold off every time it neared t.78, until it no longer mattered, so by the time we reached 2% flat the market didn’t care.
At some point, the alarm over how fast we’ve reached 3% will wear off. Especially as it moves over and under 3% as the market is wont to do.
Stepping out on a limb once again to make some predictions.
I believe we will once again see the 10-year reach beyond 3% going into the FOMC meeting. That is going to be rough. The S&P may even break under 4,000, in reaction to the speed at which both the VIX and the 10-year move up. This doesn’t seem so drastic once you realize that the S&P closed at 4131. Also, as I said, the VIX may well reach the upper 30s. I just want to take this moment to be careful how you react to Monday’s opening. The futures may be surprisingly benign and can even be quite elevated. Don’t trust a positive open. If this happens, I may sell some shares into an early rally. Why would I make such an assumption? I think that there will be some short-covering from Friday’s vertiginous close. I suspect that some professionals who have the automation to allow them to be so agile shorted the selloff that added to the downside momentum. So the indexes could look green in the premarket and perhaps the first 10 minutes of actual trading. On the other hand, if I am wrong and the market sells off hard, don't panic and sell indiscriminately. You should leave that to others. The market will indeed continue to be volatile and strongly to the downside on Tuesday and perhaps Wednesday morning even. Something I believe you may feel strange will happen. Jay Powell will announce the .50% raise and make a stern announcement that the Fed is very serious about inflation. That inflation is still rising, and he and the other presidents of the Fed will emulate Paul Volker and crash the economy to save it if need be. That is if the economy continues to exhibit growing inflation. His words might be couched in niceties but make no mistake, his intentions will be announced clearly. Here is the surprise. I expect the market to rally from Wednesday afternoon to Friday. Why would I say such a thing? Because unfortunately, the market will be in a hurry to discount all the negativity in such a short time that the market will allow itself to be consoled that some clarity has come back to the market. I would expect that during the Q&A period Powell will say that June will be a 0.75% rate rise and by going as far as reanimating Chairman Volker the market participants will also feel that they can finally trust Powell to be on the inflation case. As disruptive as these rate raises are so far (despite the erroneous GDP number) they are being absorbed by the economy. After all, the current interest rates are probably still under the inflation rate on the 10-year at +3.1%.
So what will rally? Well, if you are a loyal reader, I bet you can guess
I think money will flow back into technology names. I believe of course the cloud software components will continue to outperform the economy. All you need to do is look at the fantastic growth in AWS, Azure, and Google Cloud. Check out the results in the paragraphs below regarding AWS and use it as an example of the scute growth in the cloud. This torrid growth rate still has years to unfold. And Cloud software, whether pieces of the infrastructure on actual business applications, this market will continue to soar. Cyclicals became the darlings because of the torrid growth in the overall economy. In that environment, Cyclicals will have faster growth. That doesn’t mean technology wasn’t growing. Perhaps the tech stocks flew too close to the sun in valuation and needed to fall back to earth, but tech will show sustained secular growth. The other area that should be looked at is the chips. They have been beaten mercilessly and I think they could also rebound. A timely note by a chip analyst said that several chip companies may stand to benefit from strong cloud results, according to Bank of America analyst Vivek Arya.
In a new research report, Arya noted that spending on cloud computing has been "resilient" so far, despite global worries over a resurgence in COVID cases in China, a broader economic slowdown, and rising inflation. As such, stocks like NVIDIA (NVDA), Marvell Technology (MRVL), Advanced Micro Devices (AMD), and Broadcom (AVGO) could show similar strength when they report quarterly results. Note here that he is referencing cloud growth which buttresses my assertion about cloud software.
There are two ways to trade this market, either commit to making super-fast trades and try to break off a few points here and there, or take a slower approach. I shared with you that this year I was going to stretch my time scales for trading. In other words, any trade that I make is set up for alpha out 6 to 18 months. My thinking is that we have to get through the rising rate regime, for the first 3 to 6 months of 2022. I was too optimistic on the range, also I didn’t expect that Powell would turn up the hawkish rhetoric as high as he did. Now that we are close to mid-year, I feel we are about to see the light at the end of the tunnel. The volatility has been hair-raising of late, just take the VIX for a moment. Just a few years ago we had the VIX around the low teens. Lately, it has pretty much been nailed to the 30 level for days. I am not saying this is a “Pig Fly” rarity, but it is very unusual. It means that 1 to 2% swings each way should be commonplace. Guess what, the S&P closed below 3.5% and the Nasdaq was down +4% just this Friday. Unless you were hedged every which way you aren’t a happy camper this weekend. Unfortunately, the first half of this week as I said won't be much easier. What’s my plan?
My Trades
I have been adding to my position in Upstart (UPST) still and I have never wavered in my conviction that UPST is the single best idea I have had in several years. The more people miscategorize it the more convinced I am that the market doesn’t understand its potential.
Machine Learning and AI is the most disruptive software technology in years. Software that learns at each new loan application by measuring about 1400 different data points for every application. That means it is constantly fine-tuning the results. Well, UPST will have the first full quarter of its new car loan program. The last quarter only had the personal loans sector and still had 250% revenue growth. So yeah, I am still growing that position.
I also am very excited to let you all know that I did buy Amazon (AMZN) stock after they reported earnings. I am hoping it falls a bit more so I can buy a bit more right away. AMZN is similar in a way to UPST, and I think I should have explained my approach to AMZN better. I said buy AMZN and sell FDX and UPS. AMZN will have to spell out its plan in detail before stock analysts decide to accept the obvious, that AMZN is going to compete with FedEx and United Parcel Service. Whether you believe FDX or UPS can compete with AMZN or not, and yes, I will grant that they will compete, the playing field will no longer effectively be a duopoly. If you include the US Mail, it’s even more competitive. I am doubting whether, in the end, the US Mail will stand the onslaught. The parcel business is not the only reason I am excited to own AMZN at this discount. It’s really about AWS, while the overall e-commerce giant posted its slowest revenue growth on record, recording only a 7.3% Y/Y expansion due to a drop in online shopping, inflation, and supply chain problems. Along with a $7.6B write-down of its stake in Rivian, the results led to the company's first quarterly loss in 7 years, with $3.8B of red ink (compared to a profit of $8.1B a year ago). I think the results of the overall business have some temporary issues the true bright spot was the company's cloud business, Amazon Web Services, though looking ahead, Amazon said it expects Q2 revenue in a range of $116B to $121B (vs. $125.1B consensuses) and CEO Andy Jassy commented on "unusual growth and challenges." AWS’ first-quarter financial results were so profitable they once again propped up the entire Amazon conglomerate. AWS's operating profit soared 57% in the first quarter of the year to $6.5 billion, almost a billion dollars more than Wall Street was expecting the division to produce, according to CNBC. It’s rare to see a discrepancy that large between expected and actual results and could suggest that AWS is successfully encouraging more customers to embrace its higher-level managed services, which are pricier than its basic compute and storage services. AWS’ operating margin is now 35.3%, compared to 29.8% for the fourth quarter of 2021 and 31% a year ago. First-quarter revenue increased 37% to $18.4 billion, behind the growth curve set during the fourth quarter of 2021 but ahead of the same period a year ago.
I have talked about this years ago but now that there is a new CEO at Amazon, perhaps it’s time to spin out AWS. It can be done in a way that Amazon can still derive revenue in the form of dividends or some other vehicle, even hold a large minority of the shares, and let AWS stand on its own. Perhaps the same can be done at the outset with the Prime Delivery business. I think that eventually, the C-Suite will recognize that at some point conglomerates don’t work. In a way, I see AMZN as an analog to the young General Electric when they had a first-mover advantage in Power and several other technologies. Also, less-heralded was their management systems. I don’t want to get into the weeds too much with GE but let’s recognize that the AMZN management style is also one of its advantages. Better they create 2 or 3 mega-companies before the conglomerate grows unwieldy, do it now and Jassy will be hailed as a genius. Even if they don’t do this AMZN is a fantastic long-term investment. This quarter is just noise, I feel with strong conviction that the best days of this stock are in front of it.
I also expanded my hedging using individual stocks and some of the index hedges. I have several Puts on DWAC, it bounced on the news that Truth Social was the biggest download on Apple’s App Store. My issue is that I think the SEC will come down hard on DWAC SPAC, as they misfiled and made unrealistic projections that the SEC specifically denounced. I don’t believe Truth Social has a shot, especially in light that Elon Musk is going to rescue Twitter (TWTR) for freedom of speech. I am also betting against Starbucks (SBUX) and FedEx, for similar reasons they both have new CEOs coming in, and they both have their work cut out for them. On top of that, CEOs tend to report every negative thing and take every possible loss in their first quarter.
The rest of my trades have been about adding to current positions in Oil and Nat Gas. I am thinking of starting a new position in Shopify (SHOP), and/or ServiceNow (NOW). I would have added Alphabet (GOOGL) (GOOG) but if I am going to buy a high-priced stock right now, I want to put money towards AMZN. Also, if the VIX does reach 37 or higher, I will buy Puts, as I expect it to retreat to the low 20s.
Let me Summarize, Starting this Monday, I expect strong volatility to the downside. I wouldn’t trust positive futures Monday morning. I think there is a good chance they are being pumped up by short covering. If the market opens up high the positive I may use that as an opportunity to sell some shares. I would hold the bulk of my cash for Wednesday. I believe that after Powell announces that they are raising the Fed Funds Rate by 0.50% the market will rally into Friday.
Additional disclosure, Please note: You should not take the above text as investment advice. I am not a broker, Registered Investment Advisor, or certified money manager, I cannot give financial advice. What I am doing is chronicling my thought process. If I use the word you in a sentence, I am really talking to myself, or it was a simple typo, in no way did I mean to advise you. Always do your own research and understand what you are buying, what your risk is, and be sure before you make a purchase. Also, only trade what you can afford to lose.
Become a legacy member of Dual Mind Research in the next 3 weeks and receive an additional 40% discount.
If you enjoy my weekly stock analysis articles, You will be happy to learn that I offer a subscription service Dual Mind Research. Serop Elmayan, a brilliant young man who brings a quantitative approach to surface high probability fast-money trades, and I are partners in this service so you get the benefit of two unique investing approaches. My narrative style and his engineering approach will give you a unique value indeed. The first 2 weeks are free so check it out
This article was written by
David H. Lerner is an analyst with a decade of experience utilizing his professional background in software consulting and technology to identify market trends and provide long and short trade ideas. David employs a combination of technical analysis and market psychology to capitalize on narratives for outsized returns. He also utilizes “Cash Management Discipline,” a simple trading style to hedge against the volatility of today’s market climate.
He leads the investing group Learn more .Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
UPST, I have Put options on DWAC, SBUX, FDX.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (29)
You are inadvertently correct. After all who hires idiots?
BTW I don't really believe the employees are the idiots. The fault is always (99.99%) at the top.
