Preparing for late-cycle tightening

Wealthion had a some interesting podcasts on YouTube this last week, first with Dave Rosenberg and Stephanie Pomboy, then with Michael Pento. Same rough idea with both – prepare for the coming recession with a potentially nasty bear market.

Here’s a quick rundown of what we’re looking at:

  1. Record fiscal stimulus spending of 2020 and 2021 has come to an end. Positive GDP growth will require that private sector spending grows more than enough to offset this.
  2. Record monetary stimulus with has just come to an end and been replaced by a very hawkish tone. Only one rate hike of 0.25% so far, but the 1 year treasury rate is already 1.85%, showing that the Federal Reserve is expected to raise rates that high within a year. They are expected to hike by 0.5% in May and announce an aggressive QT cycle, reducing the balance sheet much faster than they did in 2018.
  3. The yield curve has inverted in several places, including the famous 2-year / 10-year inversion. This has been a very reliable indicator of coming recessions.
  4. Inventories excluding petrolium have been building considerably since last October, as Jeff Snider and Emil Kalinowski often point out. When this happens, businesses cancel or reduce orders and feel pressure to reduce prices.
  5. Real wages have not kept up with the rapid CPI growth. Many have felt the pinch of higher prices and have to cut spending elsewhere.
  6. Retail sales excluding energy have been coming down considerably.
  7. Mortgage rates have come up dramatically from last year, as home prices are at all-time highs. This makes an enormous difference, as a 50% hike in monthly mortgage rates can mean 50% higher monthly mortgage payments, and that drastically reduces the price that new buyers can pay. While we don’t expect a foreclosure wave like 2009-2012, it is very possible to get a wave of investment funds selling their homes as investors move their money elsewhere.
  8. The stock market has been showing considerable late-cycle behavior as both commodities and devensive stocks like utilities outperform.
  9. The Federal Reserve has come out a number of times and said that the stock market is overvalued. They are aiming to bring it down a bit.

Anyway, we are definitely in a late cycle market which has significant risks of heading lower. Meanwhile, it seems that these risks are being talked about everywhere. I’m still worried that there’s a considerable amount of hedging in the system, both in terms of outright shorts and puts and in terms of cash on the sidelines. This can cause markets to stay elevated longer than you’d think, and can even cause a massive bear-market rally.

That being said, here is my latest positioning:

  • HEDGES (8.5%)
    • 8.5% TLT Calls
  • PRECIOUS METALS (29.2%)
    • 2.4% EQX (Gold)
    • 4.5% SILV (Silver)
    • 4.2% SILVRF (Silver)
    • 3.3% LGDTF (Gold)
    • 3.1% MTA (Gold & Silver)
    • 2.5% MGMLF (Gold)
    • 2.8% RSNVF (Silver)
    • 2.5% SSVFF (Silver)
    • 2.3% HAMRF (Gold)
    • 1.0% MMNGF
    • 0.8% DSVSF (Silver)
  • URANIUM (11.4%)
    • 1.2% UUUU
    • 1.8% UEC
    • 2.4% BQSSF
    • 1.9% DNN
    • 1.9% DNN calls
    • 1.6% ENCUF
    • 0.7% UROY
  • US CANNABIS (15.2%)
    • 1.9% AYRWF
    • 1.6% CCHWF
    • 1.8% CRLBF
    • 2.2% CURLF
    • 1.8% GTBIF
    • 2.0% TCNNF
    • 2.1% TRSSF
    • 1.9% VRNOF
  • BATTERY METALS (3.9%)
    • 2.0% NOVRF
    • 0.9% SBSW
    • 1.0% PGEZF
  • CRYPTO (1.1%)
    • 1.1% XRP
  • OTHER (2.5%)
    • 2.0% DOCN (cloud computing)
    • 0.5% OGZPY
    • 0.0% ATCO calls
  • CASH (28.2%)

I reduced risk considerably this week by selling off all of my long-dated calls in gold and silver miners. In addition, all of the covered calls that I’d sold on my Uranium miners expired in-the-money, so my footprint in that space is considerably lower.

I actually looked at selling covered calls on my remaining Uranium miners last week, and I saw a lot of open interest in the May calls for a number of names. The sector is small and tight, and the individual investors are growing in it fast. I’m thinking this has some of the feel of Bitcoin in 2020, or a meme stock thats ready to soar. Anyway, instead of buying covered calls, I bought a bunch of Jan 2024 calls in DNN. The premiums were a bit pricey, but it gives me about 2.5% leverage on the money I put in, and it seems like a prime choice for retail investors to target. Anyway, we’ll see if insane new highs hit this May. To be clear though, I’ll never claim to have diamond hands – If it looks like a blow-off top I’ll likely be out halfway before the peak just like I was with Bitcoin.

With US Cannabis, I’m just keeping the same strategy I’ve been using for a while and buying a bit on new lows, but mainly just waiting for bullish federal legislation. I can afford to sit and wait years if I cap it at 15% of my portfolio. I don’t think I’ll have to wait years though, it’s gaining popularity on capital hill and a number of congressmen (& women) are buying into some of the names and ETFs. Follow @todd_harrison for updates and details on that sort of thing, as I certainly don’t follow that closely.

As for TLT, I have to admit I’m wondering when it will turn. It is deeply oversold, but if the Federal Reserve comes through with a 0.5% rate hike in May it’ll see more downward pressure, and maybe they’ll even follow up with another 0.5% rate hike in June. I still think that its just a question of when something in the financial system breaks. Some highly levered fund or some bank that no one is thinking about will suddenly have solvency issues which spread through the system causing margin calls, forced sales, and a rush for cash and cash-equivalents. US treasuries are used in a myriad of complex ways with repo markets and derivatives and such, not to mention short funds.

Anyway, it’s way too early for me to pile in. In fact, I’m thinking that I probably shouldn’t pile in at all – just add a small amount of TLT calls on major dips while leaving plenty of room to add more on the next dip. There’s no way I can time this thing … the famous 2 year / 10 year inversion hit after just one 0.25% hike, which is unprecedented. Usually it takes a number of hikes over a year or more to get an inversion like that. What that means to me is that the system is incredibly fragile and we can see a liquidity crunch followed by a TLT spike at any time. You can’t wait for the right moment on a spike, by the time it happens it’s too late to start the trade, so you have to be in a bit now. But I could also be early and find the summer pass by with a fed funds rate of 1% or higher and no blowup yet, followed by months of sideways correction in rates that leaves my call options worthless.

So anyway, there’s my rough gameplan. Reduce miners further if prices really spike, hold them otherwise. Sit and wait with the Cannabis stocks. I’m kind of thinking sit and wait with DOCN as well – it was a fast-growing cloud computing darling not too long ago, and I picked it up recently around $51/share. Ease into more TLT calls being careful to spread the investment over time, not just over price. And keep a hefty cash balance because that is the ultimate hedge in such a crazy market. If forced sales hit, I could be rushing back into a number of my favorite mining stocks on the cheap.

Writing this out really does help me think things through. Good night and Happy Easter.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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