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The Stock Market's Biggest Risk… – Seeking Alpha

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The Stock Market's Biggest Risk… – Seeking Alpha
Man with cardboard box on his head showing shocked and surprised expression

BrianAJackson/iStock via Getty Images

BrianAJackson/iStock via Getty Images
Rudyard Kipling, “If you can keep your head when all about you are losing theirs… Yours is the Earth and everything that’s in it, And-which is more-you’ll be a Man, my son!”
What you read below will probably not make sense until we look back on it a month or so from now, but here it goes…
The vast majority of this article was written on Wednesday evening. Since that time, Russia has reportedly invaded/struck non-separatist regions in Ukraine. As of this addendum on Thursday morning, NATO and the US have done nothing to deter Russia, beyond a few modest sanctions.
For context, the last instance of Russia aggression was when President Biden was then Vice President under President Obama. While not a perfect comparison, it can give us some insight as to how things could play out. History doesn’t repeat, but it does have a tendency to rhyme…
According to Wikipedia’s account:
“In February and March 2014, Russia invaded and subsequently annexed the Crimean Peninsula from Ukraine. This event took place in the aftermath of the Revolution of Dignity and is part of the wider Russo-Ukrainian conflict.
On 22-23 February 2014, Russian President Vladimir Putin convened an all-night meeting with security service chiefs to discuss the extrication of the deposed Ukrainian President, Viktor Yanukovych. At the end of the meeting, Putin remarked that “we must start working on returning Crimea to Russia”. On 23 February, pro-Russian demonstrations were held in the Crimean city of Sevastopol. On 27 February, masked Russian troops without insignia took over the Supreme Council (parliament) of Crimea and captured strategic sites across Crimea, which led to the installation of the pro-Russian Sergey Aksyonov government in Crimea, the conducting of the Crimean status referendum and the declaration of Crimea’s independence on 16 March 2014. Russia formally incorporated Crimea as two Russian federal subjects-the Republic of Crimea and the federal city of Sevastopol on 18 March 2014. Following the annexation, Russia escalated military presence on the peninsula and leveraged nuclear threats to solidify the new status quo on the ground.”
Here’s what happened to the S&P 500 and to WTI Crude Oil prices during this period – February/March 2014 (S&P down ~6%, WTI Crude up ~15%):

spy chart

StockCharts

crude oil chart

StockCharts

StockCharts
StockCharts
The Russia/Ukraine risk has been in the markets for some time now and here is what has happened so far (S&P down ~12%, WTI Crude up ~47%):

spx chart

StockCharts

crude oil cchart

StockCharts

StockCharts
StockCharts
Looking back at all of the geopolitical events since 1940, the data supports our view that the disruptions should be relatively short-lived. Data per Ryan Detrick/LPL Financial:

performance after major events

LPL Research

LPL Research
As such, we will use any further strength in Oil to harvest profits in Energy stocks (predominantly Exploration and Production names). Oil servicers should benefit from a consistent rig count increase in coming months as more supply comes onto the market. We will redeploy that capital into pockets of Biotech and Chinese/US tech that are reasonably valued – but selling off indiscriminately due to general fear in the market.
For example, do you think Russia’s invasion of the Ukraine will impact how many drug prescriptions are written in the next few months? How about number or Doctor visits, screenings, tests – or whether people take their medicine each morning? Will it impact how many people log onto Facebook to see pictures of their friends and family? We don’t. It may temporarily impact the price of the stocks (incrementally more than it already has), but the underlying business fundamentals will be unimpaired.
Wall Street is the only place on earth that when they throw a “clearance sale”, no one shows up…
Now onto our original article from Wednesday evening:
Wednesday afternoon I joined Karina Mitchell on Yahoo! Finance to discuss the relentless selling in the stock market since ~January 5. Thanks to Karina, Taylor Clothier and Sara Dramer for having me on. Watch here to get my full thinking on the market, sectors and what we are buying versus selling

My starting headline was that, “the biggest risk to the market in coming weeks is to the UPSIDE at these levels.” I proceeded to lay out the relevant facts to make my case.
The market is scared of the Fed, Inflation and Putin, however, much of it is already priced in:
What does this mean? It means that the market has spent ~7 weeks “selling the rumor” and it is now nearing the point to “buy the news.”

Oil Rig count chart

YCharts

YCharts
~24% – to get back to average Price to Book multiple.
~155% – to get back to average Price to Operating Cash Flow multiple.
~112% – to get back to average Forward P/E multiple.
Remember: recovery rallies never stop at their “average.” Just as they overshoot in pessimism on the downside, they overextend in euphoria on the upside.
It has paid investors to maintain a cyclical bias leading up to the first hike. However, the performance in the three months following that hike has struggled.”

sectors after hike

Fed tightening Data

multiples chart

BCA Research

Fed tightening Data
BCA Research
*This is not what the majority of market participants are expecting OR positioned for.
The time to buy insurance is BEFORE your house is on fire! We were buying banks and energy in fall 2020 in ANTICIPATION of rising growth, rates and inflation. Now, in anticipation of moderating growth (GDP ~6% 2021, ~4% 2022, back to trend in 2023), we are buying those sectors which can grow in the face of a slowing environment: Namely Biotech (Sector) and Chinese Tech – Alibaba.
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Each week we look at the Commitments of Traders report put out by the CFTC. We are most interested to see how the big players (COMMERCIALS – GREEN LINE AT BOTTOM) are positioning. In the two charts below (Nasdaq and Dow) I have drawn vertical lines showing when commercials were buying ahead of a big up move. You can see what happened next:

COT Chart

Barchart

COT DJIA

Barchart

Barchart
Barchart
Commercials have been buying aggressively and we are following suit (albeit in a targeted way – mostly adding to biotech and Chinese tech – which have a fundamental “margin of safety” embedded in their current low valuations). This contrasts with many of the “story stocks” that are down 50-80%+ and are still trading at >10-20x SALES – while aggressively and un-apologetically losing money every quarter (these are still “no touch”).

SPX short seller count

S3

S3

Iran related to oil price

Bloomberg

Bloomberg
To get a bear market correction ~20%, you need a recession. To get a recession, you first need a yield curve inversion. While the yield curve is flattening, it is not yet near inverting:

10yr-2yr yield

StockCharts

StockCharts
In this week’s AAII Sentiment Survey result, Bullish Percent ticked up to 23.4% this week from 19.2% last week. Bearish Percent rose to 53.7% from 43.2%. Retail trader/investor fear is at a level historically consistent at/near market lows.

Sentiment survey

AAII

AAII Bull index

StockCharts

AAII
StockCharts
The CNN “Fear and Greed” Index dropped from 41 last week to 26 this week. There is meaningful fear in the market.

Fear Greed index

CNN

Fear greed chart

CNN

CNN
CNN
And finally, this week the NAAIM (National Association of Active Investment Managers Index) (Video Explanation) dropped to 53.48% this week from 66.80% equity exposure last week. Managers will have to chase any strength in coming weeks.

NAAIM index

StockCharts

StockCharts
This article was written by
Disclosure: I/we have a beneficial long position in the shares of XBI, LABU, BABA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. See terms at HedgeFundTips.com.

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