Statement of Fact: I am bearish, states Steve Reitmeister of Reitmeister Total Return.
Statement of Opinion: I see a 50% chance that stocks will continue breaking bearish below 4,000 to retest the June lows in the coming weeks.
And the other 50% chance is that this two-week slide for stocks ends here and we continue hanging out in a trading range for the near term.
Why is this the case? And what is the best trading plan?
That will be the focus of this week's Reitmeister Total Return commentary...
Current Portfolio Holdings
Back two weeks ago, when stocks were making an assault on the 200-day moving average at 4,328, I proclaimed this to be the end of the bull run. The more likely scenario would be for the market to consolidate under that point and likely chop around in a trading range until investors were sure of their path forward (bullish or bearish).
This has proved to be fairly accurate. That’s because indeed stocks hit the wall at this major resistance level (200-day moving average).
At first, it seemed like a modest round of profit-taking. But then when Fed Chairman Powell stepped up to the mic in Jackson Hole things got ugly in a hurry.
Here were my thoughts on this vital topic from my Friday commentary as stocks tumbled -3.4% in the session:
“Anyone surprised by Fed Chairman Powell’s speech at Jackson Hole should have their head examined. No two ways about it because the Fed aims for consistency in its messaging. And they have been consistently saying that inflation is way too high and they need to be vigilant in fighting that battle.
This absolutely, positively will cause “pain” to the economy. The only question is how much harm it will do. Yes, a soft landing is possible...but a recession is more probable.
Thus, for stocks to rally on Thursday into this announcement was crazy. Like “put on a straight jacket” kind of crazy.
The sell-off on Friday was a much more sane and logical reaction to the facts at hand. However, the final verdict on soft landing with bull market vs. recession with bear market has not been fully resolved.”
I am not the only one to stress these ideas. Here is what John Mauldin had to say on the subject in his timely piece from over the weekend:
“...I just saw Jerome Powell’s very hawkish Jackson Hole comments. I am simply going to quote some excerpts while noting that he seems to want to bring on his inner Volcker (emphasis mine, quotes via Peter Boockvar and Axios).
"‘The FOMC's overarching focus right now is to bring inflation back down to our 2% goal.’
"Our responsibility to deliver price stability is unconditional....There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job."
"Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy."
"…we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting."
" Reducing inflation is likely to require a sustained period of below-trend growth," Powell said, according to a prepared text. "Moreover, there will very likely be some softening of labor market conditions."
"While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain. "
"We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done. "
John here again. That is the plan. Powell quoted his hero Paul Volcker who said in 1979, "Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations."
He talks a good Volcker, but can he stick to it? If he does, kiss a soft-landing scenario goodbye. The Fed will raise rates until they break something.”
(End of John Mauldin comments...back to Reity)
Since Powell’s speech, things have only gotten worse for stocks including three straight closes below the 100-day moving average (4,063). And now today we closed below the psychologically important resistance level of 4,000.
This sets up for a fork in the road, which is why I said in the intro there are 50% odds of heading lower into bear market territory at this time. Or 50% chance stocks bounce in the days ahead to stay in a trading range until more convincing evidence emerges to make them feel comfortable in a long-term bullish or bearish stance.
Once again let me clarify that I am bearish. As in downright bearish because high inflation and hawkish Fed equates with recession and bear markets the same way that night follows day.
That thinking made me look like an Honor Roll student back in May and June as stocks broke bearish to new lows at 3,636. But unfortunately for the next two months, the market rallied unabated making me don the Dunce Cap in the corner of the room ;-)
That was then. This is now.
Going back to the 50% chance of just breaking bearish right here and now...the statements by Fed Chairman Powell were very clear.
Expect a long-term battle to fight inflation.
Expect the economy to slow down.
Expect pain...like job loss and other economic hardship.
Some investors may not want to wait for the proof of this coming through. And that taking Powell’s word for it is good enough to keep selling stocks expecting a likely recession and extension of the bear market to follow.
This case points to stocks blowing past 4,000 right now...and then beyond the 20% bearish decline line of 3,855...and then to retest the June lows of 3,636 in the not-too-distant future.
On the Other Hand...
On the other hand, investors may need more proof of recession to press stocks immediately lower. And so there is a 50% chance that a bounce may form in the coming days to get back above 4,000.
Running up another 3% is quite common, but certainly no further than the mighty resistance that would be found at the 200-day moving average of 4,300 (actually I would be shocked for stocks to climb that high right now given the increased negativity).
This bounce would just be a continuation of the consolidation period we have talked about in the past which creates a trading range. And a great visual of a trading range is a tug-of-war.
Bulls on one side and bears on the other expending lots of energy as we chop around in the trading range. But until we seriously break below 4,000 then hard to say bears are back in charge. And conversely, without breaking above the 200-day moving average, currently at 4,300, then can’t say bulls are in charge either.
That’s great. What do we do about it?
When you add this up you understand why my hedged portfolio is still very much in place given the two potential outcomes. Works great if staying in trading range. Works even better if continueing to break bearish at this time.
Gladly it is hard to ask for more from a portfolio as we have enjoyed 11 straight sessions in the plus column. Yes, it even generated gains on the up days for stocks as well as the down days.
All in all, our hedged portfolio has gained +3.30% during this hot streak while the S&P 500 has slumped -7.24%.
As they say, “if it isn’t broken, don’t fix it”. And thus we will keep this hedged portfolio strategy in place until some other logic prevails.
For example, if the Fed can truly create a soft landing for the economy, then we will want to get more bullish which means taking profits on the inverse ETF positions and buying more stocks for the eventual return of the bear market.
On the other, more likely, hand...if high inflation and hawkish Fed leads to recession and a deeper bear market, then we will do the inverse of the above. That is to sell off the stocks in our portfolio and lean more heavily into the profits generated from the inverse ETFs that will swell in value.
Our plan is sound. Now we just have to see how it unfolds and act accordingly.
As shared above, we are on an 11-day winning streak. And like I said last week... it's not built to win every day. That is a pipe dream...but very nice while it lasts.
Instead, it is built to outperform over time with lots of variation on day to day basis. It certainly helps that four of the five stocks chosen have outperformed the S&P 500. In fact, the 1-3% losses for ACI, ICL, JBL, and PPC are a sight for sore eyes these days.
On the other side of the ledger, the +7.14% gain for the short of the S&P 500 (SH) is a timely play for sure. But gladly we bet that the previous leaders of the rally, small caps and technology, would soon flip to laggards. That is why RWM is up +8.07% and PSQ even better at +9.82%
The only other thing worth talking about is...
Higher Rates Trades (RISR & SJB)These two trades continue to work back in the right direction. RISR is back in the plus column and SJB is inching closer.
Yes, I know the goal is to make profits on trades, but as long-time members of RTR have seen...the movement of rates does not always go according to plan. Like how inflation started soaring in 2021 and yet we ended the year at 1.4% on the ten-year Treasury. Gladly we held on to our short bonds trade at the time (TBT) to lock in a 62% gain in late June.
No...I am not saying that RISR or SJB will be 62% winners like TBT. But I am saying the trends for these trades are turning more positive and leading to recent outperformance...and yes, I expect that outperformance to continue.
SJB has rallied +5.8% since the August 11th low as recession fears have risen. However, as fear of recession heightens and tips over to recession reality, then rates on junk bonds should soar and SJB provides us with a very handsome gain.
Indeed we are at a fork in the road. Either we keep tipping bearish at this moment or bounce back into the range. Regardless, our hedge is the right strategy and is ready to adjust as market conditions become crystal clear.