Market Forecast - Trading in the Zone
Reviewing market happenings this past week as well as what's to come. After last week's rally, we're back in a zone of indecision.
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Preamble: Changing My Mindset
I’ve been reading Michael Douglas’s book Trading in the Zone lately. It was recommended to me by a good friend and is an excellent book on developing the right mindset to navigate markets as a trader or investor. One of my biggest takeaways from the book so far is that I need to recalibrate my relationship with market analysis.
What does that mean? Let me explain. There is a temptation to use market knowledge as a way to derive a false sense of certainty when trading. Certainty is precious, especially when trading in an uncaring and chaotic market. The fallacy here is that the market is fundamentally uncertain. As such, market analysis should be used to derive a probabilistic edge (i.e. a higher chance that you are right) rather than be used in a futile effort to conjure certainty from chaos.
The former keeps things simple and nimble, while the latter is a psychological defense mechanism. Personally, I was susceptible to the latter.
This isn’t to say that market analysis is useless. The more you understand, the more edge you have. Douglas is simply advocating for a subtle but important change in one’s expectations for the utility of market analyses.
I’ll share my full learnings from the book in a future newsletter issue, and I’ll probably mix in some excellent trading advice from Stanley Drunkenmiller as well. Don’t miss it!
Let’s begin this week’s market forecast.
At a Glance
Zone of Indecision
The market roared back last week. The S&P 500 was up 6.45%, the Dow was up 5.4%, the Nasdaq was up 7.5%, and the Russell 2000 was up 6%. We’re happy to see that last week’s Market Forecast was at least directionally correct. We were forecasting for a market rally from end-of-month/end-of-quarter rebalancing and although we can’t know for sure what the primary driver of the rally was, it did happen.
Now we’re trading in a zone of indecision again. Back in the eye of the storm. Many think this is a bear market rally that will retrace in mid-July while some are hopeful inflation is down and the rally will continue.
Check out the Market Forecast section below for our thoughts on what’s to come.
Commodities Keep Falling
Commodities continue to fall. Many are already in a bear market by the official definition (fallen more than 20% from the 52-week high). This should help reduce inflation but it’s unclear whether the decline is the result of falling demand / a recovering global supply chain, or simply the unwinding of speculative trades. More research required. Although falling commodity prices bodes well for the market, we shouldn’t celebrate too early as they could easily rebound, especially if geopolitical conditions worsen. For one, oil seems to be bouncing off last week’s low and could very well continue its uptrend from here.
Bridgewater’s Massive Europe Short
Bridgewater, the world’s largest hedge fund, has built a massive $10.5 billion short position on European stocks. Talk about being bearish. The hedge fund hasn’t commented on this position but it’s likely that they are getting more pessimistic on Europe’s geopolitical situation as Russia ramps up its economic conflict with the EU.
Samurai Banking, the End Game
Last week, I mentioned that the Bank of Japan (BoJ) is running its money printer at full throttle to buy Japanese Government Bonds (JGBs) in an attempt to defend interest rate ceilings set by the bank. The relatively low interest rates of JGBs (compared to the rest of the world) and the rapid money printing of the BoJ is crashing the yen. The BoJ might have infinite firepower to buy JGBs, but if the yen falls too much, it’ll eventually have to relent as inflation starts rising from soaring import prices. This is what many major market participants are betting on.
Market Forecast
After last week’s rally, it feels like we’re back to trading in a zone of indecision. There are two competing narratives for the market’s trajectory moving forward.
Some believe that the market will fall in July as many S&P500 companies report earnings. The expectation is that given tighter market conditions, earnings will be much lower than expected, forcing sell-side analysts to revise down their forward earnings expectations. So far, most haven’t revised down these expectations despite declining economic conditions.
The competing narrative is that falling commodity prices in the past couple weeks will soften inflation in June and July. If so, this gives the Fed more room to slow its tightening of monetary policy. As we know, stock prices are currently super tuned to inflation and any softening of inflation will be well received.
There are too many uncertainties right now for either narrative to prevail, and the market is in a “wait-and-see” mode.
How the market moves in the first two weeks of July will confirm whether the current rally has more room to run or we’re in yet another bear market rally.
The macroeconomic factors that will set the tone in July are:
June’s CPI, released on July 13th
Biden’s meeting with Saudi Crown Prince Mohammed bin Salman on July 13th. Can he convince MBS to get OPEC to increase oil production or has US-Saudi relations soured too much?
S&P500 earnings season
The progression of the Eastern European conflict
Commodity prices
The bottomline is, the only thing certain this week is uncertainty.
I’ll end this issue with a chart on how the market has moved after each FOMC meeting. Although it’s an interesting trend, we need to remember that every moment in the market is unique and it’s unclear whether the trend will continue. Let’s wait for July.
