Ignore the Noise

There are so many wiseguys out there, they lose the forest for the trees.  Sometimes I am one of those wiseguys, but the macro situation is just so over the top bearish that you have to resist the urge to play the long side when you see these huge face ripper rallies happen from time to time during this bear market.  It is tempting to try to make money playing both sides, especially in a bear market when big moves happen quickly, and markets go up just as fast as they go down.  

But 2022 is the polar opposite of the 2021 market.  In 2020 and 2021, stocks spent very little time at the short term bottoms, as most of the bottoms were V bottoms with almost no consolidation near the lows.  It didn't give investors much time to buy the lows, which is very bullish.  So longs had a much wider margin for error, as they could take their time to sell, because most of the time, the markets were spending their time near the highs, so they didn't have to be precise when exiting their longs.  For the shorts, it was hell, as if they missed the occasional short term bottoms to cover, they were squeezed relentlessly as the markets grinded higher.  In 2022, you are getting repeated chances to buy short term lows, and the longs don't have a big margin for error.  The market is spending a lot less time at the short term highs, as longs are eager to sell any strength.  On the other hand, shorts have repeated chances to cover near the lows (sole exception was from mid July to mid August), giving them a much larger margin for error when exiting their positions. 

All this week, leading up to the FOMC meeting, I heard fast money traders and investors proclaiming that 75 bps was priced in, and that the market would have a relief rally after the FOMC announcement.  They probably won't admit it, but huge rallies in the March, May, and July FOMC meetings seeped into their brain, and they were subconsciously conditioned to believe that the market rallies on Fed days, even after big hikes.  Well, yesterday's selloff was the payback for investors being complacent about the FOMC meeting, even as Powell gave you a warning shot at Jackson Hole, that he was going to be as hawkish as possible.  I am sure yesterday's big selloff probably reset that conditioning and put in some doubt about the market outcome at the next FOMC meeting.  

One of the most important things that you can learn when playing the markets is that you will regularly lose.  Fear of losing, or giving back gains, is what leads to overtrading and trying to play every wiggle in the market, trying to buy low and sell high.  You have to have humility in this game, and realize that you can't predict all the ups and downs.  I am guilty of micro trading, trying to avoid drawdowns, but most of the time, it doesn't really add value.  

But you can predict some ups and downs, and that's when there is opportunity.  In trade selection.  Most of the time, there is no short term edge.  However, there are often longer term edges, which is less obvious because they play out over several weeks and months.   Having the luxury to play longer term time frames and be able to take drawdowns to ride the position to fruition, through the ups and downs is an edge.  One of the main reasons hedge funds underperform is because of month to month reporting, which shortens their time frames, making them unwilling to take short term pain for long term gain.  

I've been pondering how to play the upcoming economic downturn which many are underestimating.  Short SPX/NDX or long Treasuries/STIRs?  The trend obviously favors short equities, as that trade is working and it has fewer holes in the thesis, as it works when the Fed remains hawkish and inflation stays high.  But it is vulnerable to Fed pivot risk, which I believe is closer than most think (probably by November or December).  The long Treasuries/Eurodollars/SOFR trade has the obvious big hole of a Powell that is trying to be Volcker Jr., and panic puking of positions from those losing money in bonds if there is further weakness.  But the long bonds/STIRs trade will work great when the Fed pivots, and could explode higher when that happens.  Also, the positioning in bonds is light, which would make it easy for investors to increase their bond allocations from both cash and equities.  At the moment, I'm both short SPX/NDX and long Treasuries, with a bigger allocation to my shorts than my longs.  

In the coming weeks, if bonds continue to selloff and I see more signs of capitulation there, I will likely reduce my short equities position to increase my long Treasuries position.  At the moment, I prefer the short equities trade because of the uncertainty that's looming over the bond market, with regards to how far Powell will hike and how much pain he's willing to take before he cries uncle. 

Re-shorted yesterday pre-FOMC meeting, and will hold that short until I see some signs of panic, nowhere close to that yet.  The bond weakness tells me there is going to be a lot of pain ahead for the stock market.  Valuations are ridiculously high considering the financial conditions.  I know they say everyone is bearish, but ignore the crowd and focus on the fundamentals.