TGIF
I’ve been writing more in the chat this week than long form pieces because things have been moving so fast. Still, I wanted to write something longer to try to digest everything that has happened.
Put simply, we went from 2 weeks of pricing a massive rotation to small caps to suddenly pricing a recession. This repricing was sparked by:
High unemployment number Friday morning:
Weak Nonfarm Payroll number Friday morning:
Weak ISM data Thursday morning:
All on the heels of a Fed meeting where Jerome didn’t feel the need to cut. The PA is pointing us towards a recession that the market feels the Fed isn’t taking seriously enough.
I’ve warned previously that the Fed needed to cut in July to avoid an outcome like this. They didn’t, and now here we are.
Still, I didn’t necessarily expect it to reveal itself this overwhelmingly and dramatically, so I was caught a bit off guard as most of you were.
This week I went from around 10% cash to almost 50% cash at the close of the market today. It never feels good to sell while the market is nuking, as following the pack is not how you get rich doing this. So let me outline a bit about where my head is at.
The Road Ahead
This price action reminds me a little bit of December 2018 when a market worried about a slowing economy threw a temper tantrum over the Fed’s hawkish monetary policy. In that instance the Fed had hiked 4 times that year and the market wasn’t having it. Nasdaq sold off 10%+ that December.
Here, we have a similar situation. The Fed has held monetary policy at restrictive levels for quite some time, and this week we got some very cool economic data. At the Wednesday meeting the Fed declined to cut.
Now the market is selling off aggressively. The market is essentially saying that it’s worried about growth (
calling it a Growth Scare), and unless the Fed is willing to significantly ease financial conditions it thinks stocks should price dramatically lower.The question is… will they?
I think the answer is yes, but not right away. Powell is scheduled to speak at Jackson Hole on August 22nd. This is his opportunity to come out as dovish. But, in a sense, the market has to be bloody enough between now and then to convince him.
Think of it this way:
If the market prices in Powell dovishness, he can afford to stay more hawkish. So there is no reward to betting that way.
If the market prices in Powell hawkishness there is a rush to the exits. Being the first one to sell makes you the winner in this scenario. Then if he comes out as dovish you just buy back in, but you’ve faded the risk of a hawkish Powell by trimming exposure.
That results in a pretty clear game theoretical equilibrium: Sell until something changes.
Hence, that’s why I’m at 50% cash as of today. The only reason I’m not higher is that I’m hoping to sell bounces, and I didn’t reach conviction on trimming all exposure until things quieted down and I had a chance to think.
My game plan is to trim all risk exposure until the week of the 22nd, when I plan to pile back in. It will be a bit of a timing question, because everyone is incentivized to buy ahead of his expected dovishness.
Side Note: One other source of potential dovish pivot is the August 14th CPI. If CPI comes in cold it truly clears the way for the Fed to cut. The market might take that as equivalent to a Powell pivot.
Taking Stock
I wrote a bit before this week about how the regime had changed from one of chasing the maximum profit to one of reducing downside exposure and being cautious. This has only become more true. We may well bounce from here (temporary or otherwise), which makes selling underwater positions (or positions that FEEL underwater) painful.
I recommend doing a rough VAR calculation, and ask yourself what your REAL risk is if we enter a bear market. Are you positioned to survive it?
If the selling is sustained and you can raise enough cash now, you will have some pretty epic buying opportunities.
The best traders I know are good at feeling out when it’s the time to take risks and when it’s the time to be cautious. This is often more of an art than a science, as much as we try to quantify it.
Stay cautious for now, let’s let the opportunities come to us.
Good luck out there.
Please also always remember... none of this is financial advice. I’m not a professional. I quite literally don’t know what I’m doing. I’m just a guy, with a keyboard, who scored high enough on some standardized tests to think I can beat the market.