Welcome to this week’s newsletter. In today’s newsletter, I am going to discuss one of my biggest positions going into Q3 and my thinking behind it. Last week, we experienced a rally as expected, and now all eyes are on this week to see if the rally will continue. One of the major developments last week despite the rally was the bond market, and especially the junk bond market and $HYG. Notwithstanding strength in the equities, spreads continued to widen, which signals that the bond market does not believe that the bear market is over. For those of you who are newer to the bond market, know that every time the spreads widen, that means credit risk has increased, and credit risk always cascades to the equity market.
Everyone is focused on Q2 earnings. Every trader is monitoring three key stats this earnings season: real inflation adjusted sale numbers, operating margins, and inventory turnovers. Nike was the first name to report today and what really caught my attention was their massive increase in inventories!
The narrative remains the same: how likely is a recession and how much lower can the market go. The chart below makes the case regarding the strong relationship between energy prices (cost and input for many things) and a recession. Will this major jump in energy prices lead into another recession?
Leading economic indicators continue to point to more pain ahead. Last month, PMI new orders made another low while the inventory to new order ratio made another high.
I have no option trades as of writing, but I have entered a position trade for the Q3. This is one of those relative trades where I short something and then, for hedging purposes, go long on another security. These pair trades are very popular among long/short hedge funds.
I am shorting 2x IWM, and going long 1x VYM. The logic behind this trade is as follows: As leading economic indicators continue to weaken, the small caps (more cyclical) will continue their downtrend. On the other hand, VYM, an ETF based on value companies with stronger balance sheets, should be able to weather the recession storm much better than the smaller cap names.
The stop loss for this trade will be if the leading indicators start to become bullish or the Fed changes its tune and becomes dovish.
The tweet of the week goes to Callum Thomas, who showed that despite major sell offs, there is still over $40 billion in long leveraged products such as TQQQ and SPXL. I guess there is still a long way to go until deleveraging is done.
Over the last few months I have been working extremely hard to make the Closing Bell the best show on YouTube. As part of this effort, I have been reaching out to different people in the industry to join us as guests. This week, we have portfolio manager Michael Gayed on our show. We will be discussing markets, the Fed, housing, and so much more. Make sure you tune in tomorrow at market Close and also subscribe to our channel HERE.
To your success,