I Called This October Rally In August, Keep Your Seat Belts On

It was an extremely rocky road but now the direction should be clear

Yet, there were multiple reasons in my mind that called for a bullish turn in October. One reason was the observation that if the market was really going to break down it would have already done so. I wrote several articles that outlined the market turn in August, check this one out. The main reason was the extremely powerful seasonal pattern of the mid-term election year. My faith was further strengthened by these strange “bear market” rallies that had no rhyme or reason. A great example was the hyperbolic leap that was lanced by Powell at Jackson Hole. To my mind, the rally just coincided with the aftermath of the August rate rise, and it was really bear market exhaustion. As time wore on, I began to see that rallies were coming in a sequence as the market got more quickly oversold. Basically, the market was running out of sellers. We saw that in stark outline this past week when we had the first multiple-day rally since June. This move was foreshadowed by the prior Thursday’s key reversal. I wrote about that in my last article, though I didn’t note it in the title.

So what now?

Well for one, adapt to the clear change in the complexion of the market. The market is once again favoring the stocks. Another notion that I repeatedly championed these many months stick with tech. This position is not out of rote habit, I believe it is a very logical conclusion. If the Fed wants a slower economy, then cyclical names will not be raking in the cash. Only tech like cloud services and software names that are secular growers can deliver that kind of performance. An alternative sector is the healthcare sector, with healthtech and biotech having many of the features of IT Tech. My approach for the last 6 months was to have a barbell approach with tech on one end, and energy on the other. Energy has secular characteristics due to policy blunders in North America and Europe. I won’t go into detail about the many hurdles arrayed against the exploration, production, transportation, and refining of hydrocarbons. There are many sources that will explain why investment in these areas has been thwarted. Now an essential need for human survival – energy, harder to get at, and will likely be so for 7 years or more. Predictions that oil will fall below 70 per barrel are fanciful. So oil names will continue to be a great investment for those seeking income, and as a great trading vehicle because of the variable nature of commodities. I let WTI guide me, when it breaks down and falls to 83 and below, I start adding to my oil names and when it reaches 88, I start trimming. Just to confuse things further I hold energy names in my investment account where I don’t touch them, I use oil exploration names as a trading vehicle in my trading account. I find the energy sector to be very useful because they act a bit like a hedge. Very often energy dances to its own music and is not so correlated to the overall market direction.

Why is this rally any different than June’s bear market rally?

My answer very simply is, I DON’T CARE (a reference to Tommy Lee Jones in “The Fugitive”). In reality what if this is just a multiple-week rally, why wouldn’t make the most of it? That aside, things are different than in the early summer. For one, I don’t care who you are, the Fed is going to stop the .75% raises after December. If you don’t agree, I won’t try to reason with you. Just take notice of the divergence of the Fed presidents recently, this is a crucial piece of data, until now everyone was moving in the same direction. The fact that it isn’t anymore is crucial, check out the statements of Daly, and Harker. Also, it makes no sense to continue hiking at this rate, even if they did want to push the economy into a recession. If they slam it so hard, they will HAVE to lower rates, and that is just restarting the same goad to inflationary expectations. I see December as the last .75% raise or even .50%, and then a more wait-and-see attitude. Although I wouldn’t put it past our friends at the FOMC to talk tough all next year. Their big test could be February-March when it would make sense that most of the raises finally hit their mark and put some people out of work. What the Fed wants to do is to get out of the US economy. It wants to reduce its inventory of bonds, and keep the rate steady at around 4% to 4.5%, for as long as needed. Perhaps years. Another reason more attached to the midterms is that it is more than likely that the Democrats will lose the House. This is not a political statement; the stock market loves a stalemated government. It happens during the mid-terms more often than not, so it is the mid-term year-end rally that has become a very reliable pattern for many years. Finally, this very interesting development is that the market has run out of sellers. A lot of cash has come out of the stock market, and it’s my conjecture that a lot of these sharp sell-offs are more about short sellers. Their tactic is to take advantage of lower liquidity to get the downdraft going. Other shorts see the rollover and pile on, eventually, some hapless investors get stampeded out of their portfolios. Now, I think they’ve tried that one too many and in the past week(s) a bunch of them now have their noses out of joint. A non-scientific sample is the many new subscribers to Dual Mind Research who are telling me that they got pushed out of the market and into cash 6 months ago. Now they feel it’s time to restart becoming stock owners again. I thought that was very eye-opening, I think that those who have walked away from the market are starting to have FOMO.

I mentioned wearing your seat belts

The VIX is still telling us that volatility will stay at the extreme. It is a key market indicator for us, if it drops precipitously back to the low 20s then we can look elsewhere for market tells. Right now, it is telling us that we could easily see 1% to 2% and even 3% swings from low to high. Also and through early November will be earnings reports. Some leading names can have a negative effect on the rally. I am stressing the negative because forward guidance will likely lower expectations. If it is enough to stampede the market you can count on me to try and buy that dip. Another issue that could throttle the rally back is the shopping season. It remains to be seen if shoppers take all the doom and gloom to heart and cause the retail sector to fall. There are always reasons to get out of the stock market. You are likely familiar with the Wall Street credo “The stock market rally always climbs a wall of worry”. The 4th quarter is no different.

My Trades:

This past week was particularly successful for our Dual Mind Research members. We operated off of the thesis that the reversal rally the Thursday before was the harbinger of a rally this week. On Monday in an exclusive premium subscriber article, I urged participants to be “all in” except with 10% hedging using a selection of triple inverse ETF. Hedging is so easy today with these tools. Like any powerful tool, they need to be used properly, and using it as a hedge means selling it when stocks sell off, then buy the ETF back with stocks rally. I revealed the levels I would buy the hedge back and when I would sell it. Several participants were able to turn over the ETF multiple times. Not everyone has the time to do this, but if you want to protect your portfolio, this is a great way to do it.

I did add a few new names to my portfolio, I got into American Express (AXP), I thought the market punished it unfairly. It made more business loans and so added to their loan loss reserve as they always do when they have more loans. Remember that higher the interest rate, the more profitable are these loans. Another new name is Jazz Pharma (JAZZ), I have been moving into the health sector with a number of biotech names. For me, this is a fraught exercise, because I am not an expert in drug development. I am looking for stocks of biotechs that have proven to be able to get drugs through the NDA process, and are generating cash flow if not profits. JAZZ joins Sarepta (SRPT), Incyte (INCY), and Seattle Genetics (SGEN). I will likely look at other areas of health to add to my portfolio. I already feel that they add further balance against my majority IT Tech stocks.

I expect to find some great trading opportunities this week with the tech titans that are reporting this week. To that end, I reduced most of my energy names to have cash ready to scoop some bargains. In fact, we announced another DMR trading plan in the Dual Mind Community we call “fishing”. Stay tuned for next week’s article to let you know how that turns out.