Of Friday’s episodes of CNBC, Mike revisited some bearish trades he discussed on the show. Given we were and continue to be in warning mode concerning the prices of risk assets, we highlighted those trade suggestions on these pages.
It is no secret that we have been trying diligently to warn people about the bear market we are experiencing in real-time today. Our goal is to get people out of harm’s way. The goal in bear markets is (1) to preserve your wealth and (2) to make a buck if you can.
Once a strong bear move is underway, people often get stuck, particularly after a long bull move like we experienced in the US markets. People see the “buy the dip” strategy work repeatedly. The repeated success of a trading tactic encourages people to repeat it until it does not. So it is tough to go against that pattern, even as a very bearish environment builds. Rising interest rates, food shortages resulting from the war between Russia and Ukraine, the potential takeover of Taiwan by China using military force, and economic lockdown in China are but a few reasons why people would and should reprice assets.
Our theme was interest rates. We forecast interest rates to rise substantially. Rising Government Bond Rates raise the discount rate on asset valuation models, driving down intrinsic value. Risk assets become worthless. Our view on rates turned out to be correct. Once the downtrend was underway, Mike suggested a couple of trades designed to capitalize on lower stock prices.
At the beginning of April, Mike suggested an aggressive bearish put spread on the QQQs during the show. The distance between the strikes was a wide 40 points, and it cost about 10 points to put on. We recently updated this trade and said that one could close it, but if you thought the markets would remain weak, there is a bit more money to be made from time decay.
However, Mike thought it made sense to close the trade and suggested to viewers that people do so. He also mentioned a bearish trade on IWM he discussed on the April 22 show. That bearish trade is now in the black. He suggested people could close it or monetize the profit by rolling the position down and out. For the sake of tracking, we will suggest people close the trade.
So why would one close trades that are working? Are we not supposed to let our winner run? The short answer is yes. But we have discussed bearish index trades for a few months. We hoped people would pick and choose a structure that made sense to them.
The three trade suggestions still open are listed above. We will leave those trades to stand for the moment. These are very aggressive bearish trades and will do great if share prices continue their march lower or swiftly crash. We think it is essential to hold a lot of cash or hedge in the current environment, and the structures discussed are suitable for significant risk reduction.
We think any bounce will be temporary as we believe interest rates will continue to move higher as the inflation rate is more than double and closer to triple interest rates.
Our view of price action is shown above. We see the S&P500 is flirting with the February low. If this level gives way, we could see it fall in the 3,260 to 3,600 range. That could be quite a selloff. It is also possible that the S&P500 will have a relief rally, taking it up about 200 points before taking a run at lower prices once again.
Given this view of the investment environment, we think it is ok to take some profits on hedges and bearish trades, but we also believe it makes sense to maintain a hedge or insurance against an ugly tape.
As a final thought, in strong bear markets, the financial performance of individuals has a muted effect on the share price. Good news may stimulate a run-up in price, but it often does not last as the macro picture usually overwhelms the intermediate-term micro view. We see some stocks that, in ordinary time, we would suggest buying. However, we are not in normal times and find it prudent to wait for a potential washout before taking any significant bullish positions.
