Bad News – Fed May Have 6 Rate Hikes, Good News – We May Have 6 Rate Hikes; How To Trade It

Bad News – Fed May Have 6 Rate Hikes, Good News – We May Have 6 Rate Hikes; How To Trade It

Knowing that the next 6 Fed meetings will create volatility we can use that

If now that bad news is feared at a certain point on the calendar you can turn it to your advantage and make it into good news. I expect a similar pattern to last week’s Fed meeting, at least for the first few meetings. The reason we rallied a bit before this meeting was that Powell confirmed a few days before that the first rate rise will be 0.25%. Unless Powell broadcasts exactly what he will do several days before each time, I expect that before the meeting will see a downdraft. After that, the media will likely play up this report extensively leading into the next Fed meeting, it will likely affect the market with higher volatility and a sell-off. Remember that market participants hate unknowns, so the echo chamber will once again be alive with these memes to be repeated over and over again until we see a moderation in the inflation data they are:

1. Will Powell raise a half-point this time?

2. He will raise so many times and it will throw us into a recession.

3. Not a recession, “Stagflation”!

4. Powell is behind the curve and we are headed not for Stagflation, but 70’s style inflation.

To make a finer point of how the echo chamber works

It appears that some commentators have fingered Powell’s stated confidence that the US economy is so strong that it can handle these rate raises. I won’t argue against it, let me just use this moment to ask; what happened to the Stagflation crowd right now? Why aren’t they disputing this assertion by listing all their data proving that Stagflation is coming? Anyone? Ah yes, there was absolutely NOTHING in the way of facts buttressing this. Please don’t be surprised if they come out of the woodwork again to aver their data-free assertions of doom before the coming rate hikes. That is just how it works, many weak hands will be scared out of their holdings in the wake of fearful tidings thanks to them.

This will be repeated so many times that the market will get bored with it. It will take some time, as long as the economy keeps growing under the pressure not only of rate-raising but ceasing QE. I am not sure how aggressive the Fed will be in QT, I think they will start with letting the securities run off on their own for the time being. If the economy holds up under monetary tightening like Powell predicts then the rally should stay intact. I predict that for the second half of the year we should have weeks like the last one with several back-to-back gains. The trading climate should be calmly as balmy as the spring season. Though volatility will continue based on inflation news flow, and perhaps less volatility from international events.

Why did the market rally so hard? The market zoomed because it already discounted 7 rate hikes and even one or 2 half-point hikes. The real booster was the confidence of Powell in handling inflation while keeping the economy growing, perhaps slower, but growing none-the-less. This is also the key to why the tech stocks soared. Because a slowly growing economy is its jam! Secular growers will once again be rerated higher, they will be bringing the revenue and FCF growth. Stocks that show profits will be valued higher than pure revenue growers unless they too show good cash flow and an obvious path to profits. I expect the fastest growing names with the most exciting tech will once again be well priced if it all comes to pass is the message of the market that I see.

There will be other places to invest in too.

Will oil still be investable? Yes. Will the US banks large and small be investable? Yes. I see the European banks having a harder time because of ties to Russian investment. They have not been de-risked as our US behemoths. So once Russia defaults, at first the US banks will have a crack-up but that will be the buying opportunity. I will wait for the crack up then buy Wells Fargo (WFC), Morgan Stanley (MS), perhaps a Charles Schwab (SCHW), or Bank of America (BAC). These are names that I am reasonably certain have little to do with Russian lending misadventures. I will have to make sure before I throw down some dinero. The regional banks are probably a safer investment but I am no expert there, and the interest rate curve has to work in their favor.

How do I plan to turn the bad news Fed meetings into Good trades?

Working on my assumption the first few hikes the markets will assume the worst; that Powell will use half-point raises for each of the six meetings. After a while, the market will get bored of this if he stays at a quarter-point. Should I say “discount” or “priced in”? Maybe, but the market activity is the massive decisions of millions of traders, and yes a bunch are robots but the rest are humans, and humans get bored.

Have you noticed that the market is responding less and less to the horrible news in Ukraine? Don’t say “The Ukraine”, that is what the Russians want us to say to make it sound more like a region and not a country, like “The Rocky Mountains”. I am still following the news, and am still supporting the valiant Ukrainians. I am just commenting on the message of the market, and that message is “Unless the headline says Nuclear or Nato has been attacked, I am not paying attention”. Frankly, it makes sense to me to take it out of the daily equation of stock market value. So it is not me being flip using boredom to describe the market reaction. There are plenty of companies trading here in the US that have little to do with Europe, especially software technology, domestic energy and materials companies, regional banks, entertainment, or US retailers.

Will we have 6 more tightenings this year? Maybe, but it could be less.

Every Fed meeting will be live. That means they will decide at the last minute. If the delta of inflation keeps rising then they may raise 6 more times. That doesn’t mean they will do so on autopilot. I still believe they are going to be moderate 3 to 4 raises. My base case is, Powell will likely raise a ¼ every meeting, and I am counting on some moderating inflation data towards the back half of the year. This lack of clarity even though it would be positive will contribute to downward volatility before every meeting, a lack of clarity hurts market rallies. Ok, I have made you wait long enough, this is how I am going to take advantage. I am going to strongly adhere to a cash management discipline. Constantly trimming profits, and looking very hard at non-performing positions as well. Right now I am concentrating on longer-term investments so it’s ok to hold stocks that are underwater if they are of the longer-term variety. You can adopt my “trading around a position” tactic that I have outlined several times (like here) this year. Cash is the cheapest hedge, let’s use the April meeting as an example. Right now the market has been decidedly bullish, and I have already been trimming positions and putting aside cash. So if you sell and make some money, don’t put that cash back in. Instead, put aside that profit knowing that the April Fed meeting is coming. Please have at least 5 to 7% cash on the side. I will have more. The other way is to hedge. I primarily have tech names so I am looking to build back my oil and gas plays. They tend to move in the opposite direction when tech is sold off. I think NatGas and LNG will be weaker because the weather is getting nice. At some point March has a late winter storm, also traders will remember that NatGas is the fastest growing means of providing baseline electricity. I will just wait until I am certain to see the lowest entry point for names like EQT (EQT). Another way to hedge is to utilize options to express a negative position (you could short, but I wouldn’t recommend that). I would start with the VIX. It was over 30 for a very long time and it closed the week at 26, and I expect it to slide further in the next week or more. I plan to execute a call spread once the VIX breaks under 20, I am going to have expiration out to the end of April on the weekly option, with the idea that the VIX will jump leading into the next meeting. I would also look at betting against the QQQ since I think the tech rally isn’t done yet, so perhaps going long with some Puts on the QQQ. There are also leveraged ETF versions of these two that I could just purchase outright. You have to decide how leveraged you want to be. Just remember it is “buy on the rumor sell on the fact” if it is good news and sell on the rumor buy on the fact if it is bad news. Hedging is not for everyone, so I always talk about cash management first.

Here are two slow money trades I am studying, both are aerospace and defense-related

Aerojet Rocketdyne Holdings, Inc. (AJRD) is the way I am thinking about how to play the Ukrainian success in destroying Russian tanks. They make the rocket engine for both Javelin and Stinger Missiles. It’s the purest play. All they do is make rocket engines. They were an acquisition target of Lockheed Martin, one of the biggest defense companies, but it was disallowed precisely because everyone uses them for rocket engines and they could have a stranglehold on supply. They do have an activist fund, Steel Fund still in the mix trying to create value and it’s like 11% below ATH. Also, it’s not just the US giving a $1B in mostly missiles, because the UK, Germany, and every other country are also giving Ukraine their Javelins & Stingers (or their version of it) so their inventory needs replacement. Also, this is the greatest sales demo ever! Every little country will want its own Stingers & Javelins. I think it will see record sales. I don’t think the full valuation is in the stock, in the wake of the disallowing acquisition.

Boeing (BA) Boeing is sending its first new 737 MAX to China since 2019 grounding. China will use it in its own safety testing. This means that BA is getting closer to being allowed to deliver Maxes to China. Combine that with chatter that Delta Air Lines (DAL) is about to order 100 Max’s and I am starting to think BA is finally, finally, turning the corner. I have been burned by BA several times, I just know that when they do turn the corner there is probably 50 points of upside in the stock. I am considering trying one more time to get into BA.

My Trades

DocuSign (DOCU). Yes, I bought back almost $20 higher after selling it on disappointing earnings. Crazy, right? Maybe, but at this point, I am certain that tech, in general, has made its bottoms. I believe we saw the absolute bottom in DocuSign. It is wildly popular among users and I like their agreement cloud strategy as a “land and expand” concept. I also think that they have the means to consolidate some of the other document and collaboration cloud services companies out there. As a small business owner myself I would love to be able to create a contract on the fly (acquire LegalZoom (LZ)) by using AI to quickly figure out what I need, then have a collaborative space to negotiate the fine points and agree on an SOW using their agreement cloud. Perhaps they would like to add more functionality of collaboration and pick up enterprise clients by acquiring Box (BOX). I think DOCU has a great future and a potential for further growth as they evolve the product offering. They needn’t do so by acquisition, but they can. So why did I jump back in? The CEO Daniel Springer’s insider purchase of $5M worth of DOCU shares. This doubles the size of his ownership. Springer made four separate purchases of his company’s stock on Tuesday, March 15. $5 million smackers is not nothing, I don’t care how rich you are unless you are a Musk or a Bezos, I guess. He is making a statement by raising his stake 100%. He could have gone for 97% or 110%. He chose 100% for impact and depending on how rich he is, I would not be surprised if he used his current shares as collateral to borrow the funds to make the purchase. I have no way of figuring that out, but it’s my conjecture. If I am right that means he is sure things are about to turn for DOCU.

Coterra (CTRA) gave me a huge dividend. It has a variable dividend based on what the cash flow is and a standard dividend which is much smaller but still pretty good. I know I told you that I sold my Oils a while ago and I am only now buying them back. That is for my trading account. I held on to CTRA and Devon Energy (DVN) and several others in my long-term account. I am going to keep my eye out for other variable dividends from oil companies. I suspect this is going to catch on, and probably slow reckless drilling with WTI back over $100, that number is great now, but unsustainable. The days of “drill baby drill” are now over with the hatred the current administration has for the oil and gas producers. I believe others have adopted this variable dividend concept. I think it is brilliant and I don’t understand why other industries don’t adopt this as well. This way when times are flush you can give a juicier return. In cyclical industries, this would make those stocks more popular. I suspect a lot of companies are much more conservative about raising their dividends because there is such a stigma to clawing them back. This is a great financial innovation. I am pretty sure other EnP companies are doing this or about to do it. If anyone wants to comment about this I’d love to hear of other variable dividend practitioners.

Devon, I added several calls on DVN. DVN is just acting so well, I think there is more alpha there. I also think that Occidental (OXY) has great price action because of Warren Buffet’s huge investment. I would not be surprised if he just takes the whole company. I think it is dawning on everyone that oil is a necessary (evil to some) commodity and will be with us for transportation for the next 2 decades. The ability to scale EVs is coming into question both from an environmental cost and supply due to the sheer leap in demand that batteries would create. If the Greens’ demand were to take over all of transportation and power there is just not enough raw material to meet that demand. On top of that, oil will likely be a useful and sought-after commodity for the next hundred years precisely because it is so durable. One day people will shake their heads in disbelief that we burned up such useful material for transportation. They may even dig up today’s garbage dumps to access all that valuable plastic and recycle it. In any case, the pressure to under-invest by the doctrinaire woke crowd will continue unabated, putting a ceiling on more oil development and putting a floor under the price of WTI for some time. I am going to keep my oil names for long-term investments and I believe there are some great opportunities for trading as well.

PayPal (PYPL). I have added call options and bought more shares in this name. I love the price action, I think the bottom is in for this name and we could well see further upward action in this name near term. Others say the same for Block (SQ), and perhaps that is so, but I have been in this name long enough to feel like I have its rhythm. It fell to just under 100 and even as the market sold off tech names in the last 2 weeks, PYPL held that level and now has moved smartly from there almost reaching 120. I am not saying this is a moonshot. It may very well show the lower end of its trading range first to consolidate, but I would love that as a buying opportunity. There is chatter that PYPL at this level is a “Value Play”. I don’t know about that since it is still growing at about 20%, but it is just a great buy I think. Right now it is competing with my fave Upstart (UPST) for funds, that is how excited I am about its potential for quick alpha.

Zillow Group (ZG) I started a new position in ZG. I have been in it before, I am going back in because contrary to the prevailing wisdom I believe that home buying and selling will remain active in spite of the rise in mortgage rates. I suspect that the mortgage rate will not leap to completely unaffordable levels. The rise in mortgages will lower the price of housing, making it more affordable. More people are joining the workforce, better-paying jobs are plentiful. Also, a lot of mortgages were frozen because of the pandemic, a million homes are 3 months behind and another few million are in the Cares Act Mortgage Forbearance. I suspect that many of those homes will be available to the market late this spring. Many of the homes sold out in exurbia as the fear of Covid took hold is now much less acute, and employers are starting to demand daily attendance. I think that will reverse that outmigration and bring more buyers as well. At this point whether you liked the iBuy business, that experiment is now in the rear window. The old business model is back but with renewed energy and additional revenue opportunities. Right now I think ZG is under-valued.

StoneCo (STNE) is an e-commerce and payment platform focused on South America with most of its activity focused on Brazil. STNE has the privilege of being a Warren Buffet investment. The stock is a teenager now but was once 79; 600% higher. STNE reported on Friday and missed earrings but gave strong guidance going forward. I opened a position. But it ran up so strongly that I pulled my punch. I think it might come back down a bit and I will round out my investment.

Colfax (CFX) is finally going to split into two entities. I have this equity in my long-term account, but also just bought some in my trading account, March 21 is the deadline to be in the stock to be allowed to be in the split. Just realize that your purchase has to be cleared the same day. It should though. If you read this on Tuesday you are too late. In actuality, it may not be too late, wait until April 1st when they split into two entities one is a dental tech company and the other is a welding tech company Enovis and ESAB. These names are completely new, so both new stocks may fall after the split. This is because the new names will create a buyer’s strike (no one will know what they are at first). Also, a few investment banks have cut the price target for CFX, as it is going into this split. Not sure of the thinking here, other than they expect the same descent in price due to the new entities having a bit of confusion after the split. I recently had a previous split Vector Group (VGR) spun off Douglas Elliman (DOUG) the luxury real estate broker. I like the idea of a pure-play real estate broker, and the Vector Group is continuing to give a healthy dividend from selling unhealthy cigarettes.

These are all my trades for this week, other than buying back into all the oil companies as I said last week for my trading account.

So let me quickly summarize this article. I think that while we have the prospect of rate hikes, we know that they are coming. For the first several, I believe the market will sell off going into, and based upon the results we will likely have a relief rally. So let’s prepare and be mindful of your cash position. If you sell a position to take profits don’t recycle that cash back into other positions; instead, build up and husband your cash. I will be buying back in the days before the Fed meeting as the market sells off into that meeting, and hopefully selling into the rally afterward. I believe that the oil sector is a sustainable investment and trading opportunity as long as the woke politicians and doctrinaire ESG is looking to choke off investment in this sector. I understand that this is paradoxical, but if investments are hindered then the price will stay elevated.

Happy trading.

Please note: You should not take the above text as investment advice. I am not a broker, a registered investment advisor, or a certified money manager and I cannot give financial advice. What I am doing is chronicling my thought process, and I hope you gain from it. Always do your own research and understand what you are buying, what your risk is, and be sure before you make a purchase. Also, only trade what you can afford to lose.

Published at Sun, 20 Mar 2022 20:05:12 -0700