February Investment Strategy: The Market's Setup Pre-FOMC. Commentary on TSLA, SPX, and QQQ.
February Investment Strategy for Members (Previews Included): Part 1 (Released strategically ahead of schedule). Part 2 follows post Fed FOMC.
Note to Readers: Given that FOMC is happening on February 1st, I will be doing a Part 1 and Part 2 update for our Bi-Weekly strategy note.
Given that this note is time sensitive, it is written with brevity in mind and will be followed up with another Part 2 strategy post FOMC.
A preview is included here for my public friends.
Members,
Markets have been very firm in January as the “January Effect” takes hold - with risk assets staging a large comeback vs. 2022 in just the first month in 2023 alone.
The question that has many investors wondering is whether this rally will last.
While that is an important question, we don’t necessarily need to know the answer to this question if we have a specific execution/setup in place to take advantage of either scenario. There will be false breakouts/breakdowns in the process, but that’s the cost of doing business.
In this February edition, I plan to show you this methodology - it will be simple, clean, and objective.
In the meantime, the Fed has a chance to reset market expectations on Tuesday, February 1st in their upcoming FOMC meeting.
For this reason, it makes sense for me to provide a Part 1 and Part 2 of what would usually be my Bi-Weekly update. This letter will serve as Part 1.
In Part 1 (this report), I will provide a forecast of how I see FOMC playing out and what I think about the various asset classes leading up to this point.
In Part 2 (post FOMC - probably 24-48 hours after), I will discuss further the inter-market data and how pieces of the market have moved post Fed commentary.
We are now moving along into earnings season, and this Part 1 report will also share my thinking on how tech’s most visible components NFLX, MSFT, and TSLA outlook/guidance mean for the markets and how their risk/reward is setup at the time of this writing.
To recap some views that are now materializing from my previous reports:
TSLA has finally made the recovery breakout that I was looking for in late December. In the past 30 days, TSLA is now up 40% - a very stunning recovery from its low point. I was personally too early in the TSLA tactical recovery opinion, where I talked about TSLA around 130-140 on the way down as both a long-term and a short-term idea. Eventually the shares bottomed at 110 and change and then traded 160 post-earnings. For longer-term ideas, this is considered a decent win, achieved sooner than expected. For near-term Ideas, I actually consider this a loss. This is the reason timeframe is so important when it comes to investments. I will always make clear whether an idea is Long-Term or Short-Term.
I decided that much of my TSLA positioning had to be shifted into my 401K due to my view that the company is a long-term winner whereas a short-term directional opinion was simply too difficult to call. I’m experiencing a meaningful gain on TSLA in my long-term accounts, while I got stopped out in my short-term account on TSLA for a loss. I wish I won in both timeframes, but the market disallowed me from doing so. Had to practice risk management in order to ensure survival.
As we can see, the largest moves in stocks based on my experience is in the intermediate timeframe. Sometimes recoveries can happen sooner, but most of the time they take 2-3 months for the shakeout to fizzle out and for a new trend/counter-trend to form.
Many of the members who simply held onto TSLA at the guided levels are now sitting on a 15-20% ROI within a 60 day period. Pretty good - but if we’ve learned anything from 2022, it’s that good times are not to be taken for granted.
As a reminder, high-risk/high-reward ideas will almost always require an investor to sit through a drawdown before the ultimate target is met. Position sizing for high-risk ideas MUST be sized lower.
Even though TSLA worked out in the end and was a win for long-term ideas, I will focus much of my future 2023 ideas on areas that have lower downside potential, while maintaining decent upside levels.
If we think about the risk/reward of my TSLA opinion at 135 (take the midpoint of 130-140), the risk ended up being 110/shr. and the reward was 160/shr. This means that the risk/reward ratio was 25:25 or 1:1. Perhaps I’m being overly conservative, but I will focus on finding opportunities where the risk/reward ratio is higher than 1:1.
Now with this primer on TSLA completed, let’s talk about the market’s setup leading up to this point and how we are positioned for FOMC. An update on TSLA risk/reward is provided later in this note.
I will also discuss how to be positioned for a market upswing and how to be positioned if this breakout is indeed false.
There will be slippage costs involved in this analysis. You cannot obtain free market returns without being prepared to accept slippage costs if the thesis is invalidated. However, setting these frameworks in place helps you to avoid “the big loss” that can reverse years of hard work, patience, and efforts.
It is my hope to help you avoid the “big loss”, and my strategy is specifically designed with this in mind.
So long as you are flexible, you will not miss out on the primary trend that is evolving right in front of us.
We are at an inflection point ahead of FOMC. Here is the Plan. Make sure to be on my public email list if this email was forwarded to you for more strategy.
To start off this note, I want to share a very important principle that’s educational and beneficial to you.
I am going to try to find the best Risk-Adjusted Returns for the community. In order to find the risk-adjusted returns, I must also assess Standard Deviation (variation from the mean/average) in addition to return potential.
Here’s an example of what this means:
Let’s say you have ABC - and on average, it returns about 2% a month for a total return of 24% in 2023.
Let’s say you have XYZ, and it returns 24% in 2023. But in between, there where months were it rises 40% and sometimes it falls 30%.
On paper at year end, they have the same return.
However, in reality, ABC is a far superior investment because it has a much stronger risk-adjusted return. Also, from a psychological standpoint, XYZ is likely to force people out of their positions or trade frequently down to inferior returns.
Investments that have stronger risk-adjusted returns improve the “Sharpe Ratio” of your portfolio. In other words, you get a positive return without massive/gut-wrenching variance in between.
Although I am not a Financial Advisor, I do personally believe that it is important and valuable to look for stocks and assets that have strong risk-ADJUSTED returns.
We can calculate a company’s risk adjusted returns with the formula above. The most notable observation is that we divide the total return- risk free rate with the Standard Deviation. The Standard deviation is the variance that occurs in the timeframe during your investment.
As examples, TSLA has extremely large standard deviation.
On the other hand, COST has much lower standard deviation.
Now with this discussed, let’s move onto some of my core views that I wish to reiterate.
Core Views on Asset Classes
For 2023, on a risk-adjusted basis, I find TLT ETF (Long-Duration Bond ETF) to be attractive in this economic environment. Ideally, I get to add at 100 or below. But if not, I believe there is appreciation potential beyond 106+. I consider TLT ETF to be an asset that has macro support. Treasuries usually rally when the economy softens significantly.
Note: When an asset has macro support and has a strong risk-adjusted return potential, I think this is one of the BEST combinations you can find in the market.
Stocks, using the S&P 500 as a proxy, are expensive again. Fundamental investors may look at the situation and be displeased with the high valuation in such an uncertain environment. I am fundamentally bearish on the market as well. The way the market is priced is that we are priced for a soft landing/Goldilocks scenario. If you buy stocks today, you are betting on a soft landing. There’s nothing wrong with this bet - just know that these levels imply a soft landing.
However - the markets have passed a key technical observation. And in the short-term, markets are driven by supply & demand, technical analysis, and Orderflow.
Fundamental analysis is superior for intermediate-term and long-term investing, but carry little weight in terms of where the index/stocks go in the immediate future (days and weeks).
And for the immediate future, here’s the technical picture on the S&P 500.
Observation 1: The bearish macro trend line on the Weekly Timeframe is now being challenged.
Commentary: Several members have asked me whether it is time to take bullish positions.
Again, this depends on your timeframe. If the markets can pass the February 1st FOMC without trouble, this market is indeed going higher from a technical standpoint.
Looking out a few months where the Fed’s QT tightening will really start to take hold as the mechanics of the Treasury General Account (TGA) play out with the Debt Ceiling discussion, we’ll reassess then.
Observation 2: The 200 Day Moving Average (powerful signal) is now being thrusted on the upside on the Daily Timeframe.
Commentary: The market’s positioning strongly implies that we are at an inflection point where market participants are betting a Goldilocks soft landing scenario will materialize.
Now personally, I do not agree with this assessment, but the market does not care about my opinions, and in the weeks/months ahead could continue on its current trend.
Based on these 2 clean, technical observations, I am adding the following conditions into my plan.
Previously, a false breakdown beneath 3980 after my mid-month Jan note on the E-mini recalibrated my net worth asset allocation to 60% Cash /40% Equities from 50/50.
As a reminder, I am not interested in capturing every last tick of upside or buying at the exact bottom. My strategy is to focus on regions where I believe buying/selling makes most sense on a risk/adjusted level.
My plan from previously still applies, and I’m now adding the following conditions with different plans:
Plan A: Ride the Upside until proven otherwise.
The 200 Moving Day Average on SPX is 3966. A 1% pierce below this level is around 3930.
If you want to set a Stop, this is the logical place to put it: 3930-3966
Hold all positions otherwise.
Plan B: Evaluate reducing positions at 2022 Jackson Hole levels (SPX 4200)
Back in August 2022 Jackson Hole, the Fed reiterated its famous line “it will do whatever it takes to tame inflation.” At this point in time, the SPX traded around 4200.
I see 4200 as an extremely powerful resistance level to overcome.
At that point, the S&P 500 sells at ~19X forward earnings again, and that is expensive with CPI at 6.5% last month, Fed Funds Rates approaching 5%, and Unemployment set to go to 4% in the coming 3-6 months.
If 4200 is breached, it is likely that the market has done the following:
Correctly anticipated a Soft Landing
Flushed out all short-sellers and the next rug-pull will restart
Given that my base case is that a soft landing scenario is only a 20-30% chance outcome, I generally see a 4200 SPX as a strong opportunity to set stops at that level and reduce long positions should we go underneath it.
Or, move up a trailing stop to 1% of 4200 around 4150 and do action in that region.
What would weaken my skepticism and increase the likelihood that a soft landing can indeed be achieved is if next month’s CPI is in the 5.5-5.7% region. If the Food line item or Housing line item makes a dramatic turn south, even if Inflation isn’t defeated in the long-term, the markets will behave as if it has.
An SPX at 4300-4400 is not out of the question if this is the case.
However, if CPI is still above 6% next month, the market’s gains are on borrowed time and will be given back in the future. CPI needs to make furious progress in order to support the current market’s levels.
Macro data points are extremely binary, which is why it’s best NOT to predict exactly what they will be.
Rather, forming a plan to stay in the market on conditions and accepting that some slippage costs are involved is the only high-probability way to stay in a skeptical bull market while emotionlessly pulling the plug if the market retraces.
In summary:
If the market is meant to retest 3600 later in 1H 2023, then risk-reduction at 3930-3960 (200-Day Moving Avg) is a strong move.
Don’t try to sell at the very top. Don’t try to buy at the very bottom. Accept that it is not possible to do so.
If markets are trying to head to 4200 (now 4060), a Stop at 3930-3960 keeps you in the game as objectively as possible as that is the 200SMA with a 1% Margin of Error.
Here are my thoughts ahead of the February 1st FOMC
I think stocks are expensive ahead of the Feb 1st FOMC. Risk/reward is diminishing for Bulls.
However, how it trades after will depend on where the index is before.
Here’s my thinking:
PRE FOMC (Some scenarios that I’m thinking about)
If SPX is at 4100+ by Feb 1st before Jerome gives the announcement, it will take only a bit of hawkishness in the speech to retest 4050 and under.
If SPX is at 4000, the risk/reward is balanced with only a marginal edge to the Bears.
If somehow, the SPX is at 3900 by Feb 1st before Jerome’s speech, there is a slight bias to be tactically long for a brief period of time.
It would be strange to break the 200 Day Moving Avg on the downside before the Feb 1st FOMC in my view. This means that market participants know a hawkish speech is coming.
POST FOMC (Some scenarios that I’m thinking about)
A Rally: If the Fed hikes 25 BPS, and Markets marches towards 4200, I still see this as an opportunity to reduce. Whether the Fed raises 25 bps or 50bps doesn’t matter. The duration of high rates is the factor driving a slow build-up in unemployment.
A Selloff: If the Fed hikes 25 BPS and markets selloff back to 4000, I’ll revisit inter-market data at that point. I’ll still keep a Sell target at 3930-3960. If this range holds, I’ll hold.
A nothing burger: If the Fed Hikes 25 BPs, and the markets don’t move, I will watch the following for the next steps on clues:
2Y Yield: What is the 2Y Yield doing?
Dollar: What is the dollar doing?
Gold: What is gold doing?
A 50 BP Hike Scenario: If the Fed hikes 50BPS, and the markets sell off, this may be painful in the short-term but I see this actually as better for the intermediate term macro picture as there is a strong resolution to kill a long-term problem (inflation). This may send markets back down to 3800 and change, but this would actually be healthy for a more constructive macro picture as CPI does not have a chance to resume its resilience.
If the SPX is brought back down to 3600 (2022 Lows) but inflation is slayed for good, we will finally be able to remove one very large bearish catalyst in the marketplace.
No one wants this level of short-term pain. But it may be necessary to answer the inflation question.
If inflation isn’t completely solved, all future market advances will be suspect to reversals. This is because there will be deep uncertainty over the future of Fed Funds Rates. With FFR at 5%+, major advances in interest rate sensitive sectors (like tech) is on borrowed time.
FFRs essentially NEED to go down later this year in order for these advances to be sustainable.
As of today, the market has clearly signaled via the 2Y Yield that we have reached peak hawkishness and that the terminal rate will not be much past 5%.
If this assumption turns out to be wrong, things will unwind very violently and incredibly swiftly.
Let’s move onto earnings. Just a few thoughts here. More commentary on an ongoing basis.
My thinking on corporate earnings this quarter so far.
Ahead of this quarter’s earnings, many EPS estimates have already been reduced. For this reason, do not be overly excited if companies “beat” top-line/bottom-line estimates.
The most important observation from here is the guidance.
I have a couple points to share about the following companies. I’ll provide both brief fundamental and technical commentary.
MSFT: I found this quarter and next quarter’s guidance to be a bit softer than expected. The way MSFT is trading right now, the market is giving the name the benefit of the doubt due to its long-term execution and management excellence.
Long-Term: MSFT continues to execute and technical analysis does not matter as much. The current level is likely profitable if given an 18 month timeframe. However, do not rule out a revisit to 200-210.
Near-Term: A revisit to 252-260 is an opportunity to reduce at the macro downward trend line.
NFLX: I’m not impressed by Netflix’s fundamentals, and although I’m not a shareholder, this report doesn’t make me excited about their prospects. The name trades rich, and ultimately I think NFLX will give back much of these gains in the coming 60-90 days.
Long-Term: Not interested in NFLX as Disney+ and other competitors have strong offerings and NFLX is moving pricing lower with ads (an unattractive offering, in my view).
Near-Term: I believe NFLX faces significant hurdles ahead. What would invalidate my view is if NFLX has a close above 390 on the Weekly Timeframe. With Weekly RSI at 67, that is a tough ask.
TSLA: The extreme positive performance in TSLA over the past 30 days is a symmetrical response to the intense bearishness it faced in December. While the shares can go higher, I do not rule out a revisit to the 140 region upon a return of macro weakness.
Long-Term: For ultra long-term investors, I don’t change my stance of what I said earlier. The company may trade significantly lower from here, but the end value in 3-5 years is likely higher than where it is today. TSLA must be treated like a VC play to some extent. There is a certain mindset that must be adopted when it comes to long-term investments. If TSLA revisiting 100 bothers you, then wait for my other risk-adjusted ideas as markets give us better pricing.
Near-Term: Daily RSI is now at 65, and that means the name went from very oversold to near overbought in the span of 30-40 days. This is an excellent area to put a Stop-Loss here to protect profits if you are trader.
In my Part 2 of this February letter after FOMC, I will digest what the Fed says and provide you an update.
The FOMC is on Feb 1st. Most likely, I will be able to provide Part 2 on the following day.
If the Fed says anything incredibly disruptive, I can do a same-day analysis. However, any same-day analysis will be briefer as long-form research content takes time to create.
I’ll be on the lookout for further ideas. Most names in my coverage universe offer very little margin of safety on the long side at the moment - especially if markets retrace.
We are in a Holding period.
In the meantime, everything I’ve discussed above is my personal plan and I’m happy to share it with the good folks. Just remember that my guidance should be treated as just one more data point in your strategy.
I’ll have the Bi-Weekly Dashboard updated once I send out my Part 2 post FOMC.
Best,
Larry