By: Steve Smith
Despite suffering the third worst seven trading days over the past 50 years stocks are still groping for a bottom. In fact, this past week…
registered many of ‘the worst’ numbers on record as the SPDR S&P 500 (SPY) dropped 11% and is now down about 24% for the year to date.
I’ve hammered away that the bear market began last summer but the indices were being propped up by the mega-cap tech names such as Apple (AAPL) and Microsoft (MSFT) which masked the destruction going on beneath the surface number. Those generals have now retreated back towards the berm behind which the high growth soldiers lay decimated.
Part of what makes this bear market one of the worst is it has not spared any asset class. This is the first time ever that both stocks and bonds have dropped by more than 20% over a six month period.
Indeed, we just witnessed the largest destruction of wealth evah. Note, this is in notional terms not adjusted for inflation, which of course has been one of main reasons for said wealth destruction.
I say that somewhat tongue in cheek but this speaks to the issue that much of the pandemic gains during 2020-2021 were fueled by free (and not so funny) money. We are now simply some of the $9 trillion injected into the system over the past two years. And let’s not ignore there was some $20 trillion of various stimulus over the prior 10 years as the Fed stayed in a crisis mode of Zero Interest Rate Policy (ZIRP) well after the actual financial crisis of 2008 had passed.
It would make perfect sense for valuations and market capitalization to return, at minimum, the pre-pandemic highs. This would target SPY to the $340 level or another 10% lower.
Back to Where We Came
While I’m still of the mind that the major market indices ultimately have another 10%-15% downside, I’m starting to wonder if maybe the worst is over and the risk/reward lines up for leaning to the long side in the near term.
A couple of reasons for my tepid bullishness:
I have plenty of complaints regarding the Fed’s action over the past 18 months (why the heck were they still buying mortgage backed securities even as the housing market was overheating) but I’ll cut them some slack on believing some of the inflation pressures would be ‘transitory. It’s taken longer than expected but it appears the supply side of the inflation input seems to have peaked.
Sentiment has become fairly pessimistic which usually acts as a contrarian indicator. Put/Call ratios have been trending higher suggesting there is now a decent safety net of put protection in place. This would allow both intuitions and individuals to step into a buy the dip mentality knowing their downside hedged to a limited risk.
This speaks to one of the paradoxes developing; the mantra among money managers seems to be, “we are seeing compelling valuations but it’s still too early to buy.” Essentially, they are like kids on a ledge above a dark lake, pushing each other forward saying, I’m sure it’s fine, you go first.
On the individual side even as sentiment indicators are clearly bearish there has still been a net inflow into ETFs and index based mutual funds. This is a case of watch what I do, not what I say.
What has Options360 been doing? Honestly, not a lot. The first directive of trading a bear market is to side step downdrafts and avoid losses. The next, and harder step, is establishing short positions which take patience and well defined entry and exit points.
This approach has allowed this service to grind out a 15.5% return for the year-to-date. Not something we can retire on, but it allows us to survive and sets us up to thrive in coming weeks when I think some fat pitches will be coming our way.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.