(Real Money) - No one said bear markets would be easy to trade. Indeed, they are known to suck in the bulls and bears, trapping them both at extremes. The preceding sentence summarizes the state of the market as investment round table discussions are filled with extremely good arguments on both sides, and the market is doing what it wants outside of that.
From the lows seen back in October, the S&P 500 and more so China, emerging market and European indexes have rallied significantly, leaving all the recession pundits behind. As the market makes new higher highs and lows, the narrative becomes self-fulfilling and all the cash that is burning holes in the pockets of investors is forcing them to invest as they fear losing out on excess returns despite missing the breakouts.
Markets not only are about getting the direction right but also about choosing the right stocks. All throughout 2022, everyone was long technology and non-profitable small-cap companies, which hurt them as they gave away all the 2020 gains and then some. Since the Russian war on Ukraine, investors have piled into commodities, specifically oil and gas, as they feared the world was running out and that the oil large-caps would be supportive given the lucrative cash flows generated.
Oil now has fallen about 50% and gas is back to pre-Ukraine war levels, decimated and down 80%, but investors are still long these commodities as they wait for the China rebound and the eventual supply deficit that is forecast. The start of 2023 has seen a massive rally in all the laggards of 2022, namely technology and small-cap names, as well as a bunch of alt-coins and meme stocks at the expensive of oil, gas and commodity names. This is hurting performance across the board as people are left holding stale longs and seeing markets rise yet do not see their performance in the black.
From peak recession fears in November, the market is now trading as though we are past the recession and the Fed is about to pivot and eventually cut rates by year-end. The playbook for that move would be to buy long duration stocks and technology. It seems traders are getting ahead of even the Fed and positioning for something that may happen at the end of the year. But we know that expecting quantitative easing is not the same thing as getting QE. The Fed is still in the midst of raising rates, albeit at a much slower rate, but the thing is that rates are going to be higher for longer, i.e. restrictive. The problem is that investors are so used to trading the same stocks using the same playbook of the past decade that they refuse to see how this time around may suggest a slightly different posturing.
Brent crude is trading below $80 a barrel and stale bulls keep holding on to the commodity long in the hope that once China comes back oil prices will rally. However, China has fully reopened now with flights back to pre-Covid levels, yet the price remains low as there is weakness elsewhere in developed markets that are seeing a surplus of inventories in the first half of this year. Investors nonetheless are convinced that no matter where oil's price goes, OPEC+ will be there to support it, hence they choose the oil large-cap names for the pure yield element even though their performance is at best flat in a rising market.
The Fed has changed the way the market functions with its decades of QE, and the investors know nothing other than to buy the dip of racy tech names as the Fed always saves the day. But we haven't been in an environment where inflation stays higher for longer and the Fed is forced to keep rates higher for longer. That is a very different investment cycle, one that predates even our mentors.
Time will tell how this plays out but chasing old favorite stocks hoping to make 100% as they rise is never a prudent strategy nor is following just charts, as economic fundamentals and other cross-assets do play a role. We all know what happened back in 2006 through 2008. An economy in a recession takes time to showcase its skeletons, but don't be fooled, they are there lurking in the corridors waiting to come out.
By Maleeha Bengali
February 14, 2023
