January Investment Strategy: Looking for a reasonably stable start to the Month, followed by looming danger
2023 has Begun: Strategy for Members. Previews Included for Public Friends.
Note: I believe our Substack/Patreon members have found my timely posts in between Bi-Weekly updates to be exceptionally helpful.
For this reason, I will be doing more of those strategy posts alongside my Bi-Weekly posts. Treat this note as a big-picture map of where I see markets heading. Additional follow-ups will be made as the landscape changes.
To properly balance my workload, I will be making the Monthly Slide Decks much more brief/concise/shortened and produce more Strategy notes like the ones you’ve seen in December ‘22.
This post will be simultaneously posted to private Substack and Patreon members. A preview is included here.
January Investment Strategy: January 1st to January 15th
Members,
We’re starting 2023 on a fresh note. Happy New Year to everyone - I’m excited to share my initial roadmap on how I see 2023 playing out, quarter by quarter.
Yes - the challenges in 2022 have been severe, and I don’t expect them to go away in the first half of this year. But there will be green offshoots to take advantage of and I intend to help you spot these opportunities.
I know that many members appreciate my additional posts in between Bi-Weekly reports. For this reason, I will continue to do so to keep you updated with timely strategy.
On top of everyone’s mind is most likely how we will start off this year, and how we will progress as 2023 moves along. I will attempt to answer these questions and more in this January note.
To avoid redundancy, my core views can be seen as the cumulation of the previous 4-5 posts. This note will be forward looking and will not recap those views.
In this January 1st Half report, here’s what we’re going to do:
Provide a high-level overview of the market’s landscape (Q1-Q4 of 2023)
Provide high-level guidance on macro themes for asset allocation
Discuss stock-selection themes from a quarter by quarter basis
Provide an overview of market structure throughout this note
A note on Tesla’s 4th Quarter deliveries and China’s political reshuffling
I want to provide a holistic overview of how I see 2023 will play out. This way we have a big picture roadmap.
Then I will drill-down and focus my commentary on Q1. As we progress throughout the year, I’ll provide additional thoughts as the landscape evolves.
A Big Picture Overview of My Initial Thinking of Q1, Q2, Q3, and Q4 of 2023 based on current information. Let’s get into it.
Q1 (Jan-Mar): In my opinion, the hardest part of 2023 will be Q1 and Q2. Survive this period of time, and Q3 and Q4 of 2023 will be better. Here is the landscape that Q1 will present to us.
The Unemployment rate is likely to see a sharp acceleration in Q1
S&P 500 EPS estimates and earnings season outcomes will be challenged.
The Fed is likely to take Fed Funds Rates to 5-5.1% in Q1
Inflation Headline CPI is likely to visit the 6% region in the first 3 months of the year
Inflation Core PCE is likely to enter the important 4-4.5% (currently 4.7%)
Nasdaq may temporarily fall under 10,000 as an index, but there will be certain areas of relative strength. Will be discussed on an ongoing basis.
QT may make the liquidity picture start to become a concern, and the drainage of liquidity via reverse repos is going to start causing markets to have more violent swings both on an intraday and also longer-term timeframe standpoint.
Q2 (Apr - Jun): Q2 is likely to show continued economic deterioration via PMIs, Unemployment Rates, and QT will continue to take its toll on the liquidity picture. Earnings this quarter will continue to deteriorate, and hopefully this quarter marks the bottom in SPX earnings estimates and outlooks.
The Unemployment rate could be in the neighborhood of 4.5-5.2% during Q2. This increased Unemployment rate will greatly challenge consumer confidence/
By this time, credit card balances are likely to have ballooned to uncomfortable levels, and the real economy will perhaps finally see the lagged effects of monetary policy
Consumer Discretionary stocks will face the greatest volatility in Q1-Q2, but perhaps will see the largest rebound in Q3 and Q4 once the expectations are reset
Discretionary Stocks such Disney, Expedia, Marriot, and other consumer sensitive names may see an area of long-term accumulation.
Within Q1-Q2, we could see pockets of the VIX spiking past 30-35+ again, and this means investor pessimism will continue to get louder.
A market capitulation event with VIX above 40+ is likely to be a strong buying opportunity even if it does not feel like it at the time.
Q3 (Jul-Sept): By Q3, I expect the economy (housing, PMIs, job markets) to have deteriorated enough such that the market volatility forces the Fed’s attention.
The potential for the Fed thinking about cutting rates will start to re-control the narrative in Q2-Q3. Timing is uncertain, but the beginning of the “Fed Pivot” may take place during this period of time. I do not believe the Fed will be able to hold interest rates above 5% for the entire calendar year of 2023.
The effects of a Fed Pivot are not yet 100% clear - do not think it is unanimously a positive event
Falling EPS estimates matter far more to the Street than the Fed Pivot.
If the Fed Pivot happens during a time when EPS estimates and margin estimates are stable, then the market will find a solid footing
If the Fed Pivot happens when analyst are bringing down estimates on revenue, EPS, and margins, the Fed Pivot will actually confirm that the weakness is real and could bring upon greater fear.
Just like monetary policy is felt months later, the effects of tightening and loosening will not be priced in stocks right away.
Be careful about the narrative that Fed Pivot = Instant Market Bottom. The markets are always more nuanced than this.
Q4 (Oct-Dec): I do believe that by Q4, there is most likely a much toned down sentiment surrounding hawkishness. As talk surrounding interest rates come down, oxygen will be bred into the economic landscape again. Sentiment surrounding the outlook for 2024 brightens and the companies that have survived up until this point will be allocated the scarce capital left in the marketplace.
As Deflation becomes the global narrative, the most promising Growth companies (and their stocks) will finally catch their bid. This could come anytime from Q3 to Q4. Most likely not Q1. Base case is Q3-Q4. Most optimistic situation is perhaps second half of Q2.
Inflation Headline CPI may end the year in the 4-5% region after a long fight down to this area. I expect significant back-and-forth Inflation volatility in this region. The path back to <4% for Headline CPI is not going to come easily.
Inflation Core PCE should be in the 3-4% region, an area that will stop the Fed from becoming overly hawkish. I believe the Fed softens their stance when Core PCE is under 4%.
Unemployment may end the year between 4.7%-5.5%, which results in a very challenged landscape in the real economy in the U.S
I also want to share some scenarios on broad index guidance, but please understand that everything that I’m about to discuss is contextual. They also represent my opinions only and are used for my planning purposes. They could diverge from what the market actually does.
On the Emini S&P 500 Index (this is where SPX and SPY are derived from)
On the SPX and General Markets, in terms of ranges and timing.
In a previous note written on 12/17/22 (View substack/Patreon equivalent), I highlighted an important Daily chart demand zone on the Emini S&P 500 for members between 3740 and 3830 as a bounce region. As you can see from the chart above, December’s selling pressure has so far been absorbed by this demand zone so far in green. While retail folks outside of our Community were expecting us to break 3500 in 2022 again, that was clearly not my base case, and so far, that has held up.
Early on in 2023, the S&P 500 could have green offshoots back into the 3950-4050 region in my opinion to trade close to the macro trend line drawn above.
If this level occurs at the beginning of the year, before the analyst estimate cuts in late January, then this level is most likely appropriate for risk-reduction. Anything at the top of this range (or above) is a gift to reduce stocks, in my own personal opinion.
If the SPX bounces BACK to this level AFTER Q1 earnings (Feb-March), this level is more real and I then become open to the concept that 4100-4300 can once again be a viable range.
Caveat 1: The index rally will be more exciting (but less reliable) if tech stocks rally. Tech stocks have their work cut out for them at 5% Fed Funds Rates.
Caveat 2: The index rally will be “more real” if tech is actually underperforming inside the SPX, and leadership comes from broad based sectors Financials, Healthcare, Industrials, Energy. In my Fall research reports, you may recall that I indicated that the SPX’s changing composition where Energy and Healthcare is higher will make it harder for the index to fall significantly even though interest rates are high.
I view the Nasdaq and tech sector underperforming SPX until Inflation Core PCE breaks below 4%. Once I see that data point, I think the tone changes at the Fed, and the Nasdaq will once again become market leadership (in a durable way).
Among the 3 indices SPX, QQQ, and DIA (Dow Jones), the best ETF to buy on massive dips is most likely the DIA in Q1 and Q2. The QQQ will regain its footing after we see a 4% Core PCE Inflation rate. The QQQ should start performing again in late Q2 to Q3. Q4 2023 for technology should be much better than the Q4 we had in 2022.
On Fixed Income Bonds (TLT ETF)
I view the selloff in TLT ETF to be relatively short-lived, and believe that the mid to low 90s region will be a good opportunity to re-add to this ETF which has macro support.
The TLT ETF represents bonds at the 20-year part of the yield curve. This part of the yield curve moves along with economic expectations. Yields climb based on a variety of factors, one being economic growth prospects and the other being investors’ appetite for risk.
With the economic outlook weak and investors looking to lock in yields, there are limits to how high yields at the long end part of the yield curve will go. For this reason, the TLT ETF which is a proxy of this will have much more durable support than traditional equities which are based on very uncertain future cash flows.
The one caveat is if Headline CPI soars back above 8% (now 7.1%) or Core PCE rockets back above 5% (now 4.7%). If that happens, we’ll see lower lows in TLT ETF first.
As with everything, I’ll keep everyone updated.
In terms of macro positioning and thoughts on this, I will break out my thinking into several key areas.
First, asset allocation. Then by industry. And finally by stock-selection ideas.
Asset Allocation
As you know, the most important driver towards your net worth and financial journey is your asset allocation. In other words, how much are you positioned into Cash, Stocks, Bonds, and Real Estate, and etc.
Stock-Selection impacts the returns from your equity portfolio, but how much it impacts your net worth depends on your sizing relative to your overall entire capital base.
Now, I’m not a personalized Financial Advisor, but I do think the following guidelines are helpful. Opinions that I’m about to share assumes the liquidity with no ownership of Real Estate, because that complicates the picture.
If you are young, capable, and stable in your Career, I believe an ideal 2023 allocation could be the following.
Base Case (this is where I’m at):
50% Cash.
50% in Risk Assets (Equities, Bonds, Etc)
As markets get to the local lows (SPX 3300-3500), VIX near 30-40
40% Cash
60% Equities
Upon a rally, immediately rebalance back to 50/50
As VIX gets to 50+
Temporary 35% position in Cash
65% position in equities
The reason you never want to go below 30% is that you do need to ensure your psychological well-being.
Many folks think of cash as a depreciating asset. This is not true.
You cannot function properly during moments of dark panic if you don’t have cash on the sidelines.
2023 is too uncertain to go under 30% cash.
If you are older, more conservative, and are near the end of your Career. Then for 2023, I think the following may be appropriate.
Base Case:
70% Cash
30% Equities + Bonds
15% Bonds
15% Equities
As markets get to the lows (SPX 3300-3500), VIX near 30-40
50% Cash
30% Bonds (TLT ETF)
20% Equities
Equities should almost be exclusively in Consumer Staples safer Dividend Yielding stocks. Themes like China, Semis, FAAMG, and Growth must be allocated as a significantly smaller portion.
Upon a rally, immediately rebalance back to 70 cash /30 equities.
If SPX trades under 3300, I’ll discuss my plan at that point.
In terms of timeline and a general roadmap for 2023 that are likely favored by Investors.
Q1: Dow Jones type stocks. Defensive stocks. TLT ETF. Hold Growth, but in smaller portions. China likely to start basing/moving higher.
Q2: Defensive stocks. TLT ETF. Hold Growth, but in smaller portions.
Q3: Growth names (U.S. and China) may start finding appeal - a potential timeline to nibble more. Keep TLT ETF. Watch for signs that Value underperforms Growth.
Q4: Growth names (U.S. and China) most likely are a solid idea getting into 2024. Keep TLT ETF. Value starts to underperform Growth.
Stocks/Themes I like going into Q1 2023
Context of Q1 Timing: I think the first 5-10 trading days in January will be marked by stability and a more optimistic feel. The January Effect may allow investors who did not reduce at 4100 SPX in December to potentially reduce at 3930-3980 in January (the region just under the downward trend line).
As we start heading into earnings estimates season in mid-January, be extremely careful.
In other words, any significant strength in the first half of January is a good opportunity to re-balance/de-risk, in my view.
For stock-specific levels (such as TSLA, Semis, China), I’ll comment more as we navigate through January.
Wanted to provide a high-level map for now.
On Tesla
The key catalyst for this week to drive sentiment in the first part of the trading week will be Tesla’s 4th Quarter delivery figures. Analysts’ consensus were looking for around ~420K cars delivered. Morgan Stanley had the most pessimistic forecast at 399K.
Breaking news is that Bloomberg just reported that TSLA 4th Q deliveries were 405K.
This is about a 4% miss in a very challenging backdrop. I don’t want to make any predictions on how TSLA will trade as markets reopen, but I do think that this is a respected figure in this macro environment.
With Tesla’s current pricing, I think the shares may have been priced for under 400K deliveries in 4th Quarter even if consensus was 420K. How the shares trade will depend on how the Street interprets the forward outlook.
Overall, Tesla is still oversold but it is oversold in the context of an extremely challenging macro backdrop. With the sheer number of investors sitting on material losses on TSLA, I believe rallies will be sold into. In other words, any rally is in the context of an intermediate-term decline.
In terms of direction, I see a green offshoot rebound taking TSLA to the 130-145 region before sellers come back to pressure the name to trade back to 2022’s 110 or lower levels.
For this reason, if it gets to this 130-145 region, I’m going to do my best to walk away at break-even or slight losses/gains depending on what the market gives me. At the moment, even if there is a recovery, I do not think the recovery is on sound footing given that the Street typically looks more heavily at the outlook (which I’m sure we can all agree will be difficult).
Bottom Line is that I really do like Tesla but I think my entries are too early based on the stock's price action behavior from December. Given that I run an Investment Community, I have to be cognizant of issuing guidance to help folks preserve capital as best as possible - especially in 2023.
Elon’s large block sell order of TSLA occurred between 150-170 and the CFO Zach Kirkhorn had net sales in the 170-190 region.
At the moment, I don’t have much evidence to support a hypothesis that the shares can durably trade above those levels that key insiders like Elon and Zach sold at in December.
What will make me structurally more bullish on TSLA rather than eye it for a counter-trend bounce is any newsflow if they produce a car in the price region that matches Toyotas or Hondas (30-40K mass market pricing) or if Elon officially hires a new CEO for Twitter. I believe these two catalysts are clear signals that will compel Institutional investors to re-evaluate TSLA at its current 22-25 forward P/E for long-term investment and not simply a rebound trade.
Important Events coming up that should be on everyone’s radar.
December CPI: Look for a break below 7% Headline CPI in order to stabilize markets. A rebound to 7.5%+ Headline CPI could send SPX to the 3600 region.
January 25th-26th FOMC: The Fed is likely to start discussing their forward guidance more clearly
December Fed Minutes: This is important, but we already know what the Fed is doing/thinking.
December Jobs Market: In some ways, the Jobs market is a conundrum for markets. If unemployment goes up, folks will fear a recession. If unemployment stays “artificially” low due to the way non-farms payrolls are calculated, then folks will think the Fed will stay hawkish. Either way, the Jobs Market is a 2023 wild card for the Fed and markets as a whole.
On China
I want to bring your attention to a recent change in political leadership in China’s high-ranking government official list.
Wang Yi was previously the foreign minister, and has been replaced by Qin Gang. This has been confirmed by China’s National Ratio.
From my observations Wang Yi has always adopted a more hawkish sentiment towards the U.S. in their communications. On the other hand Qin Gang has been a bit more balanced in his tone.
Following a recent conversation with Antony Blinken, Wang Yi continued to criticize Blinken on the U.S approach towards competition with China.
For China investors, this move marks as a direction to further soothe U.S-China relations.
Wang Yi will replace Yang Jiechi as Director of the Party’s Central Commission for Foreign Affairs and the next top diplomat. This means the ideology of Wang Yi is here to stay in the background, but the face of Foreign Affairs will be from a more balanced figure (Qin Gang)
The last 60 days of policy in China has been marked by what appears to be a significant change of heart across a variety of topics:
On managing Zero Covid
On resetting relationships with the U.S
On more stimulative policies at the PBOC and also the real estate sector
As I’ve mentioned in my Fall research notes (Oct/Nov), the pros and cons of the centralized leadership structure in China means that progress (or lack thereof) can be made in exceptionally short periods of time.
I believe the reason China is doing this is so that they can get economic growth back on course.
After all, competing with the U.S. will require China to operate at peak performance. That is simply not possible when the country is in constant lockdown and also constant sanctions and restrictions that slow down China’s corporate ambitions.
It appears the landscape for China-U.S. relations to improve in the near-term is being set with concrete steps.
I believe at some point in the years ahead, the competition will become much more intense than what we saw in 2022.
But in 2023, we will see a push back to normalcy between U.S. and China. And this means that investors may be able to put this key risk below those of other pressing matters, such as the Real Estate recovery and the continued monitoring of how Covid will impact China.
Largely, this means the market risk premium for the KWEB ETF may be slightly lowered. Any Big Retracements in KWEB (down to 23-25) are an opportunity to enter/add more for an eventual test to the critical 40 level, which has eluded investors for all of 2022.
For KWEB, a break above 33 would mean that 40 is in sight.
That’s it for now - Going forward, I’m going to produce more strategy posts in between my Bi-Weeklys so that you’re updated.
Hope everyone has a Happy New Year!
-Larry
Additional Key Resources (Corresponding PDFs Below and also uploaded in Dropbox):
Monthly Slide Deck (Macro - Now made more concise)
Bi-Weekly Thoughts on Key Companies in my Coverage
