I called February’s big reversal, here’s why and what we’re doing

In my last article, I called the current sale for February 1. I’m starting to think I should just add two weeks to the turn of the market I’m modeling for. Why am I so confident that a retreat is about to occur? Why: a) Last year the market taught us a hard lesson: price/earnings ratios cannot skyrocket. b) Earnings matter as much as revenue growth c) stock price should be priced higher with earnings growth, not hype. d) The historical P/E ratio is 15 to 16 times, at the January high the S&P 500 PE ratio was much higher. e) part of the rally in equities was the decline in interest rates, which was prompted by the misguided notion that the Fed was going to pivot. So the Fed Chairs get to work trying to reverse Powell’s interview where it seems to be optimistic, which only reinforces his reintroduction of disinflation in his description of our economy. They reiterate that interest rates still have a way to go and are likely to remain high and restrictive for years to come. On Friday, February 3, market participants were treated to surprisingly positive economic news – Total non-farm payroll employment increased by 517,000 in January and the unemployment rate fell to 3.4%, reaching a percentage of record unemployment of +50 years. This time, “Good News was Bad News”, lending credence to “Higher for Longer”. This means higher interest rates for much longer.

This is preparing for a “key reversal” and a retreat on Thursday

I was surprised that the sale continued until Friday morning. I assumed the bottom buyers would come in this morning to buy yesterday’s lower prices. Instead, the bearish buyers bought at the close and the S&P closed 8 higher at 4090. That said, I think this reversal portends further selling through the end of February.

Last week we had the biggest hedging clearing in years, with hedge funds and institutions closing the most compared to mid-2022. In a massive repositioning to riskier tech names and junk stocks from January’s massive stock market rally. Fund managers have cut $300 billion in bearish bets, starving the market of pent-up demand just as the Federal Reserve warns its battle against inflation is far from over. All good things must come to an end and so does the January Rally. This sharp reduction in coverage causes the VIX to begin to revitalize as a reflection of market fear. Since it is inevitable that hedge funds will start to cover themselves via short positions.

This graphic was created on February 9

The chart above of the S&P 500 where the market will go down. We see a double top, and the uptrend has been broken. The S&P 500 is down.

It all comes down to interest rates as the 10-Y climbs above the trading range it has been in for weeks. On Friday, the 10-year was above 3.75%, above what it was. Additionally, Tuesday’s CPI release is the catalyst right now. As I mentioned above, the rising stock prices of tech names are only rising because interest rates were benign. We have learned that the market ends up paying attention to stocks whose valuations have inflated. The higher the S&P climbs, the more it is reactive to bad news and bored with good news. The CPI (Consumer Price Index) could trigger even higher interest rates during a sudden rise in inflation or a pullback depending on whether or not it should continue disinflation.

The new horizontal green line marks where I could see support coming in. Dip buyers will be hard-wired to dip a toe into the Tech and Junk names.

The hopeless dream of a Fed pivot pushed the stock market higher in January, led by its riskiest assets. The market hasn’t deserved that kind of happiness, or at least Wall Street’s definition of happiness. At 18.3 times expected earnings (4090/223 at Friday’s close divided by estimated earnings of 23), the S&P 500 is approaching levels unrelated to reality. The market has maintained valuations above 18x only twice in the past 30 years – in the tech bubble and at the height of the pandemic recovery. I think the S&P will pull back enough to be between 15 and 16 times. Can the index increase this year? Of course, as inflation continues to decline, the Fed will finally stop rising. The S&P may rise in anticipation of the economy recovering and earnings rising. That’s why I believe we’re going to consolidate, I hate to repeat that I talked about this in my last article. Let me add that we could do another jump like we did last month, but then gravity will bring it back down. As the year progresses, the range will narrow until a new direction emerges. There is a good chance that we will return to a new bull market by 2024.

What we did to the Dual Mind community to take advantage of this shift in the market.

In my last article at the end of January, I explained the reason for our Long/Short approach to the market this year. Should we have adopted this strategy last year when the market crashed? Yes, well, we started this approach last year when mere hedging wasn’t enough to stem the losses of one of the worst years for stocks in decades. I try to be as real as possible. In hindsight, we should have taken much larger hedges on indices and more short positions on individual stocks. As we all know, hindsight is 20-20. We continued to select individual stocks to generate downside alpha. We also cut positions to build up cash, according to the Cash Management Discipline. Personally, this involved cutting my “Tech Titan” stocks like Microsoft (MSFT), alphabetical (GOOGL), and Amazon (AMZN), as well as Intuit (INTU), and ServiceNow (NOW). It hurts to cut stocks from these positions, but part of CMD is reaping profits gradually. Now I am waiting for these positions to pull back and I will reload at prices below where I sold them. Let’s talk about the new positions I added since in my last article I talked about single stock shorts via Put options. I took advantage of a momentary drop in the price of Eli Lily (THERE IS), and got shares as low as $319 to $327. If the sell that develops LLY returns to this level, I will add to it. Right now LLY has bounced back to $345, I’ll probably hold this position for up to 12 months. I think LLY is at least getting back to its old highs. I also rebuilt my position in Biohaven (BHVN) the price action is excellent. I added Caterpillar (CAT) on the long side, as well as Schlumberger (SLB), transoceanic (PLATFORM) and ShockWave Medical (CRUSH). I’ve also added several other shorts via sales options: Expedia (EXPE), To assert (AFRM) and PayPal (PYPL). All of these names have reported problematic earnings reports, so if the overall market goes down further, they should lose more than the overall market. I also have many other longs but I’ve had them for months so I don’t feel the need to list them. I’m only saying this so you don’t think I’m super bearish. I am not, I refer to my previous article and to the beginning of this one. I just think the rally has gone too far, and once it drops enough, I’ll add shares back to the old positions on the long side and start new ones. I connected my movements to the short side. The title of this article is “What we do”. In our community, we usually take a stand together, but that doesn’t mean I’m always the leader. In fact, some of the members took a short position against Tesla (TSLA). I will follow them in this position if I have the opportunity to find an entry point. We chat and chat and debate sometimes, no one has to follow the strategy. If I can’t convince the members, then I have to rethink a premise or an opportunity. Ok, that’s it, if the S&P 500 rallies on Monday, I might add to my shorts and cut more longs.