Second Trade Setup of 2022 In Full Bloom...But What If Fed Folds?

The second trade setup of 2022, short commodities, was coming in view in late May. Most simply, the play is based off the 10-year yield. When yields are rising, value leads with commodities out front. Depending on if its a bull market (healthy growth) or bear market (stagflation), financials can also be a winner. Flip the script for a rally in yields: commodities lead the way lower. Value, including financials, sink. Depending on market context, there could be a general decline in all stocks or growth/tech could outperform value.

Right now we have the commodities down leg underway, across the board. See: Adios inflation. The next piece could start momentarily with a breakout rally in stocks led by the Nasdaq (tech/growth).

The Adios Inflation post also shows the Eurodollar yield curve inversion. This indicates the market expects the Fed will reverse its rate policy soon. This can be played with calls on Eurodollar futures, or by accumulating assets that could enjoy a turbocharged rally should the Fed capitulate.

It's important to separate the two legs of this trade. One is short commodities. This is a major top akin posts in late 2021 such as The Coming Tech Bear and The Day the Stock Market Dies in November, This Might Be A Big One in late November and The Bear Pill in December. Those posts discussed a major top in technology stocks that began that very month. I could write similar things about commodities, but the charts speak for themselves.

The wildcard is the Federal Reserve and the overall economy. I fall into the trap of speaking as if the Fed matters, when they are followers. But the Fed is a good signal because they don't move until it's clear the market is diverging from their policy path.

Trade setup one: press commodity shorts on all pullbacks. Assume crazy targets are possible such as CL $60 over the next three to four months.

Trade setup two: if the stock market rallies right here, a potential Fed capitulation opens up crazy rally targets. I was too conservative in buying $120 strike IBB calls for July, they're almost 40 delta already. Those calls are up 500 percent so I can't complain, but that was a failure of imagination on my part. My goal is always to maximize the profit on move. I plan to hold these calls though, assuming a rally kicks off. .

There is still time to get on the XLC trade. maybe you have your own ideas. Crypto, ARKK, take the wildly volatile stuff and tack on some extended targets. Don't get too crazy, this isn't a new bull market.

As for that rally, it is D-day today. I'll wager the market will either be breaking out or melting down come Monday or Tuesday.

Trade two could turn into something bigger if Goldilocks comes traipsing out of the forest, but I don't see it happening today.

The third trade setup of 2022 that I foresee from today will be selling off the rally stocks and getting positioned for the next leg down in the bear market, probably in the historically tumultuous September/October period.

In sum, trade one is high confidence. That trade wins if "stocks" rally or if stocks meltdown from here. Note that commodities are probably the better trade via futures or ETFs than energy and materials stocks in a stock market rally, because a market rally could slow the losses in funds such as XLE, COPX, etc. If the market breaks down, stocks could lose more than the commodities.

Trade two is a temporary trade that probably has a lifespan of two to eight weeks. It does offer as much upside as trade one if it turns into this year's major rally. My analog is March to May 2008 when stocks rallied 15 percent. If the Fed capitulates, it could map closer to the "mega rallies" such as in spring 2001 that took the Nasdaq up 50 percent, but in this case the 50 percent gains would be in ARKK and crypto, with Nasdaq up something closer to 20 to 25 percent. Options-wise, trade two is compelling as I've been showing with the XBI, IBB and XLC trades. I'm sure there are more trades out there, and better trades, if you go hunting for them.

No comments:

Post a Comment