Since I first picked up a copy of IBD in 1999 I was hooked. Being interviewed by them is a true honor as Bill O'Neil is a legend in this business. It was great talking current markets, risk management, and some stocks I am watching. Below is a link to the interview. Hope you enjoy!
https://www.youtube.com/watch?v=kOMXk7bqbLc
The hardest part of investing is making judgement calls in real time, especially at inflection points. How do you decide if this is a new bull market or just a nasty bear market rally? Ultimately, we really won't know until its too late and already obvious. In hindsight all market calls are easy. However, in real time that is what separates the good investors from average. Successfully trading the markets is not about certainty. It is about putting the odds in your favor and exploiting the edge you have. We make bets on probabilities and then let price action be the final determinant. Below we'll lay out the data and hope that helps shape a thesis. Lets get to it.
One of the better gauges of sentiment we study is the monthly BofA fund manager survey. It provides a good read into the positioning and sentiment of fund managers around the globe. Below are the key takeaways from the most recent survey.
Bottom line: "pain trade" still up according to Feb FMS; investors least pessimistic since Feb'22 but nowhere near optimistic enough to say positioning a sell catalyst; cash as % AUM still >5% & FMS BofA Bull & Bear Indicator up just a tad from 4.4 to 4.5.
The Big Numbers: 68% say China reopen is inflationary, 66% say US$ to fall, 66% say it's a bear rally, 65% say yield curve to steepen, 64% no Russia-Ukraine truce this year.
On Macro: last Nov net 77% predicted recession…in Feb just 24% do; global growth expectations now least pessimistic in a year (net 35% expect weaker economy); biggest "tail risk" still "higher-for-longer" inflation (i.e. monthly core CPI readings of >0.4%).
On Policy: dovish optimism on Inflation & Fed rising…most investors since Mar'20 see rate cuts next 12 months, most since Sep'21 expect steeper yield curve.
On Risk: cash levels down to 5.2% from 5.3%; most "crowded trade" no longer "long US$," replaced by "long China stocks" & "long IG bonds."
On AA: investors OW cash (42%), OW commodities (15%), UW equities (-31%); record 3-month jump in exposure to EM stocks (Chart); short-covering tech/consumer stocks, more length in bank stocks, investors UW defensives vs cyclicals 1st time since Apr'22.
Contrarian trades: long stocks, US, tech and short cash, China, banks.
Fund managers remain pessimistic even after a strong rally to start the year.
Cash allocations remains elevated with plenty of dry powder to be put to work.
Long cash and emerging markets and bearish on US equities and real estate.
Below is a tweet from Ryan Detrick showing some bullish precedent based on research from Ned Davis.
On top of that the market breadth has been impressive on the upside. In fact, on January 12th we had two massive bullish momentum breadth signals fire off. The Deemer BAM and the Whaley breadth thrust. Below is a nice recap from Quantifiable Edges shows the multiple breadth thrust signals and the forward returns associated with them.
If this is a bear market rally, the current move is par for the course. If we remain in an extended bear we could have further to go on the downside. This tweet from Charlie Bilello compares the rallies to the 2 other nasty bears in 2007-2009 and 2000-2002.
If inflation remains elevated longer but we don't slide into a bigger recession maybe the worst is behind us for the markets. But also we could be dealt with a frustrating sideways market. This analog from Jurrien Timmer from Fidelity makes that case.
If the current rally persists, traders will be pricing in the possibility of soft landing and a Goldilocks economy. That would look like inflation pulling back but the economy avoiding a recession. If that happens the market should be slightly overvalued here. If not, we may be at the end of the range from a valuation perspective. Research from 3Fourteen Research sums this up nicely.
Based on the evidence above, most traders remain cautious and underweight equities with plenty of cash on the sidelines. They are positioned for a bear market rally rather than a new bull market. If this is a new bull, they will be forced to chase price higher which in turn could drive the market even further as cash from the sidelines piles in. The markets remain elevated with regards to valuation, but if the breadth thrust signals a new bull market, the valuation will remain higher for longer. The contrarian trade is to stay long US stocks until sentiment gets overheated. Markets seem far from there as of now as it continues to climb the wall of worry.
I recently penned my 2022 year end investment letter and discussed some traits that have made us successful over the last 15 years. We don't have all the answers and no one does, but sticking to our niche and focusing on risk management has kept us in business and able to offer an above average return with less risk to our clients. Below is some of the letter and touches on some themes that have contributed to our success.
While WCP was down slightly in 2022, we protected most of
our gains from the previous bull market and stand ready to deploy capital when
conditions become favorable for our investment style. Investing capital is not
about knowing things or predicting the future. Clearly Wall Street analysts are
not good at making predictions. Every single brokerage house predicted the
S&P 500 would be higher in 2022. To be honest, more information is always
better than less. However, to be successful you don’t need to know everything
about monetary and fiscal policy, economic indicators, earnings estimates, statistical
analysis, etc. Rather, a good trader needs to accept the unknowns and embrace
our fallibility while exploiting the edge that tilts the odds in our favor. The
foundation of our edge relies on our ability to reduce exposure during bear
markets through our relentless pursuit of risk management above all else. We
don’t weld ourselves to a specific opinion or prediction. Instead, we sift
through all the data to produce a thesis and use price action to confirm our
bias. And when the facts change or the tape isn’t confirming our direction we
are quick to cut our losses and reassess our positioning. We remain humble and
know it’s not always the most intellectual that survives a bear market but
rather the portfolio manager that is best able to adapt and adjust to changing
market environments.
2022 was a trying year for investors as almost every asset class lost ground. In a rare occurrence both stocks and bonds fell in unison as the Fed turned from investors’ best friend to the largest headwind. A 60/40 portfolio mix consisting of S&P 500 and US Aggregate Bond Index returned -16%. That was the second worst year on record since 1976. It was a year about survival and keeping losses to a minimum. We never like drawing down some profits from previous years but what made our small loss last year more impressive was the returns of risk assets that comprise our investable universe. It was an extremely difficult year in the growth sector which typically makes up our long exposure. On top of that, every speculative asset class got hit hard from growth stocks to cryptocurrencies to IPOs. For example, Tesla, which had been the source of alpha over the last few years fell over 65% for the year. To put in perspective how challenging the environment was for growth investors, look at the returns below for select growth assets.
Our key to success was attributed
to our flexibility as we were very early to reduce
risk exposure when our market indicator flashed a sell signal during the
beginning of this bear market. We stayed
very light on capital allocations as opportunities have been limited on the
long side. A continuation of our edge is knowing when our strategy is not
performing versus when to press the accelerator and go for big wins. As the
environment changed from easy money to a more difficult tape, we avoided most of the carnage
during the bear market by staying nimble, keeping risk under control
with low exposure, and remaining disciplined. During challenging times, it is
best to avoid landmines, keep powder dry, and live to fight another day. As
we weather the storm, we don’t plan on rushing things
but once the narrative changes and opportunities present themselves, we’re in a
great position to exploit the upside.
These are not easy times for investors as there are plenty of headwinds to deal with that could make 2023 another tough year. While bear markets are painful to endure, they are healthy and give the market a chance to reset. However, I try not to get sidetracked by splashy headlines, macro news, and noise in general. We are very excited about the path forward due to the technological revolution. In 2023 and beyond, we anticipate the largest technological breakthroughs with regards to some of the major obstacles we face as a country. Themes that are currently emerging to solve our most pressing issues are: artificial intelligence, clean energy, automation, obesity, cure for various types of cancer, and rare disease therapies. We remain optimistic, as it is an exciting time to be a part of the investor class. Our game plan is to remain cautious and flexible as market conditions evolve. We are like a big wave surfer in that it’s never clear just when and where the next big one is going to surface. When we identify the next monster wave, we’ll be prepared to pounce on the break, ultimately providing life-changing opportunities going forward.
I hope you enjoyed and after a difficult 2022 we are excited for what 2023 will bring!