Bear market rally?

Rauol Pal of Realvision suggested that this rally is being led by re-balancing of stock/bond funds, which would explain why you see inflows into stocks while Cryptocurrencies, which are not part of mutual fund flows, continue to struggle.

I anticipate fierce rotations under the surface, so here’s an RRG chart from stockcharts.com:

It looks like anything consumer-related got killed this week, which makes sense given the large inventory builds at Wal-mart and Target, and the earnings disappointment and layoffs at Amazon. Money is piling into energy, utilities, health care, and materials for that combination of inflation hedge and defensive sectors with dividend yields.

I actually sold covered calls on a lot of my Uranium miners a day early. I saw this awful bearish wedge pointed out on Uranium Insider, and decided to pull some money out by selling out-of-the-money covered calls for the big June 17 expiry:

The rally friday was actually strong enough to get a lot of my covered calls close to the money. With CCJ for example, I sold a $25.50 strike. I will very likely follow through with even more covered call selling next week, so if this rally continues through June 17 then I could end up significantly reducing my position again, just like I did on April 15th.

Note that I am actually very bullish Uranium miners in the next few years, but we are in an incredibly steep rate-hiking cycle as the economy is clearly turning down. This chart right here should scare anyone invested in risk assets:

Note that the data here is monthly, and it only goes through April 30th, but it already shows a -$162 billion (-17% so far) decline in margin debt with another -$173 billion (-29% further) to go to bring us to the pre-Covid trend or -$293 billion (-61% further) to bring us to the March 2020 bottom. Keep in mind that reduced margin debt is pulled directly from the stock market, and that it is the visible tip of the iceberg when it comes to financial leverage. We are clearly in a de-leveraging cycle right now, which is driven largely by the rate hiking cycle.

As risk-free interest rates are pushed higher, a few things happen:

  1. Margin debt gets more expensive. This also affects all other forms of financial leverage from new mortgage loans to collateralized loans in the vast and opaque repo market.
  2. Bonds lose value as interest rates go up, so any leveraged bond funds (perhaps using the repo market) will be able to borrow less from their bond portfolios. If the bond values fall enough, they could get a margin call in which case they have to sell off some of their bonds to pay down the margin (or repo) loan. Meanwhile, their income goes down as the spread between the interest of their held bonds and the interest on their repo loans shrinks.
  3. Stocks also lose value in this type of environment, which could lead to margin calls if the investors (or funds) don’t sell enough to keep their margin levels manageable.
  4. Non-leveraged investors start to get better options if they decide to reallocate money more defensively. Stock market declines encourage them to consider these options.

The way I see it, the Federal Reserve is intent on raising interest rates until we start to see some real forced selling here. They see the combination of sky-high asset values with CPI in the high single digits for over a year as a real shot to their credibility. Consider that the pre-pandemic peak in the S&P 500 was 3,380, which is 23% lower than Friday’s closing price. In addition, look at median housing prices:

Median housing prices are up 25% from the pre-pandemic norm. The federal reserve likely realizes there are significant risks to popping this bubble, and that it will take time to see this come down, but they are certainly of a mindset to want to reduce these back to levels they consider “normal.”

Right now, I’m still of the mindset that I don’t want to sit on the sidelines while massive amounts of money change hands. I’ve still got decades before retirement, and I still need to get significant returns if I want to have a chance at getting anywhere. My tiny 401k will simply sit in a money-market fund until the Fed goes back to easing, and then it will go back to 100% stocks, and I wouldn’t be surprised if that simple strategy beats my individual market performance – which is pretty dismal to date. So anyway, what now?

I still believe that we’re in the early stages of an upturn in commodity prices. There has been underinvestment for a decade, and we simply need a lot more investment going into energy and mining in the future. Still, a deep recession will hurt things badly between now and then. Mining and energy were extremely choppy from 2000-2003, so you really had to take profits on those rips higher. They also had an incredible run from 2003-2008, but even there it was incredibly choppy with opportunities to sell overbought rips and buy oversold dips throughout. Needless to say, I need to keep this in mind and be ruthless about selling this next rally so that I can be there to buy the following dip.

This includes the uranium miners. The funamental story behind them gets more and more bullish by the day, so I don’t want to let my exposure go to zero, but in a de-leveraging environment you need to sell those rips so that you have money available when others are forced to sell.

I also believe that the ramifications to the financial system will be tremendous as the federal reserve continues there hiking cycle, and that they will be forced to stop for fear of creating a systemically destabilizing event such as the Lehman Brothers bankruptcy in 2008. With the amount of leverage out there, they will probably hit the limit this summer and be forced to immediately pivot back down to zero interest rates and easing. The best strategy is actually to wait on the sidelines until this moment hits, but I will more likely increase my hedges, primarily in Jan 2024 TLT calls, after the next 50bps rate hikes go through around June 15th.

So here’s my plan going forward…

  1. Sell more June 17 covered calls on Uranium miners if they continue to rally. Same with my other miners if they catch a serious bid. Some of these are things I can’t sell covered calls on or the calls too cheap to make it worth my while, so I’ll just sell them if they rally a lot by June 15th.
  2. Sit and wait in mining stocks that are still way down. I know it sounds stupid, selling winners and sitting on losers, but I am long-term bullish on the sector so I’m not selling a stock like LDGTF which is below the March 2020 lows, or MTA which is hovering at 2-year lows, or AG which is between the two. I’ll be careful about allocating more here at the moment, but sentiment in precious metals miners is in the tubes while the metals themselves aren’t doing too bad. Same goes with my battery metals miners.
  3. Sit and wait in my US cannabis names. I’m not going to add on new lows, I put in enough, but I am still overall bullish on the sector and my allocation is low enough where I can just wait it out.
  4. Buy more TLT calls and possibly SPY puts if they’re cheap enough, but not until after the federal reserve meeting.
  5. I should not buy anything for the next 3 weeks.

Here’s my latest portfolio allocation:

  • HEDGES (13.9%)
    • 13.9% TLT Calls
  • PRECIOUS METALS (34.5%)
    • 4.3% SILV
    • 4.1% AG
    • 3.5% MTA
    • 3.1% SLVRF
    • 2.9% EQX
    • 2.9% LGDTF
    • 2.5% SAND
    • 2.1% RSNVF
    • 2.0% SSVFF
    • 2.0% MGMLF
    • 1.8% HAMRF
    • 1.4% DSVSF
    • 1.1% MMNGF
    • 0.9% BKRRF
  • URANIUM (22.2%)
    • 4.5% CCJ
    • 3.4% DNN shares & calls
    • 3.0% BQSSF
    • 2.9% UROY
    • 2.8% UUUU
    • 2.2% UEC
    • 1.8% ENCUF
    • 1.7% LTBR
  • US CANNABIS (15.3%)
    • 1.9% AYRWF
    • 1.8% CCHWF
    • 1.6% CRLBF
    • 2.2% CURLF
    • 1.7% GTBIF
    • 2.2% TCNNF
    • 1.6% TRSSF
    • 2.3% VRNOF
  • BATTERY METALS (10.7%)
    • 5.1% NOVRF
    • 4.0% SBSW
    • 1.6% PGEZF
  • CRYPTO (2.1%)
    • 2.1% XRP
  • OTHER (3.2%)
    • 2.6% DOCN (cloud computing)
    • 0.5% OGZPY
    • 0.1% ATCO calls
  • CASH (-1.8%)

I actually did add to a number of things this last week, in small amounts at least. This includes a number of Uranium miners like LTBR, UUUU & UROY as well as some precious metals miners like MTA and LGDTF. They were pretty beaten down early in the week so it was hard for me to resist.

It looks like I’ll lose my DOCN allocation soon though, as I sold a June 17 $45 call on it when it was still sitting at $38. It absolutely soared since then so its in-the-money now. Closing this off at a 10% overall loss at this stage in the cycle isn’t bad for a beaten-down tech name.

Anyway, I hope I gave you some food for thought here. Good luck on your trading strategies going forward, and be careful out there!

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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