End of a Currency Carnival Era，Rising Global Stagflation Risk & Investing Strategies

     End of a Currency Carnival Era，Rising Global Stagflation Risk & Investing Strategies

I、The end of a currency carnival era with lower expected returns and rising stagflation risk

On this Wednesday, January 26th, after the Fed released its policy statement, all major stock market averages jumped, with GME、AMC、ARKK jumped as much as 19%、13% and 5.8% respectively, I was very suspicious regarding the sustainability. Then Fed Chair Jerome Powell gave the presentation at the news conference and the big jump of all market indices began to shrink somewhat, it was right then, I wrote the above and sent to the near 500 members of【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】 WeChat group. Last Q4, I mentioned a few times that 【The risk really can't be ruled out that Cathie Wood's ARKK could repeat the sudden thunderstorms of Bill Hwang's Archegos Capital late this March. Again, the collapse of China Evergrande and iron ore price mentioned quite a few times here can be used as a good warning, yet there could be some support for ARKK around the $60 area (very likely lower) .】What happened today is very similar to that of December 15^th and the following day, and it is indeed a very good confirmation that the punch bowl will have to be taken away soon, thus a currency carnival era will be gone for good, with lower expected future returns. I mentioned this a few times, “Shorting long duration shall very likely be the key for most of the time in the near future, such as Cathie Wood's ARKK, with most components barely making any money, that's a way too long duration”. Especially considering, with baby-boomers pending retirement already posing a high risk to the future deeper hole of pensions and health care benefits, the pandemic will definitely exacerbate some long-term risks, such as the supply-side pressures from de-globalization trends, the quickly more than doubling Fed balance sheet、the extremely high fiscal deficits and national debt, which have been counting on extraordinary levels of monetary accommodation through very low interest rates. However, especially during the recent two years, deep negative real yields has greatly boosted global macro leverage and quickly added to the huge amounts of inefficient debts, and meanwhile helped worsening the entrenched habit of very low net domestic saving rate which is for sure a big handicap of funding domestically for the future US economy growth, thus added the growing risk of stagflation, especially when quickly tightening financial conditions somewhere next year leads to widening corporate credit spreads, then things could get ugly, even with the risk of huge debt induced deflation coming onto the table, and such risk can't be underestimated, as the overall flattening yield curve has already started to flash light yellow warning signal. Now, as curbing high inflation has become the most important political task in this mid-term election year, it's very hard to image that such arduous task can be achieved economically pain-free. In fact, some parts of the world have already fallen into recessions, with the US may have the risk to follow within two years, which will surely be a huge destruction of real wealth, as printing huge amount of money out of thin air is like mortgaging our future generation, which will significantly sacrifice the expected future returns.

Latest update on today, Jan 28th：Very recently, all major indices are technically way oversold. Apple's quarterly report on Thursday boosted the short-term market confidence, leading to an apparent oversold rebound today. However, Apple's service revenue growth will apparently slow down, and quite some supply chain issues still need to be resolved even though global re-opening shall gradually relax such concern, plus it's not that cheap at all, considering the rising rate induced revaluation, its giant size and potential antitrust regulatory issues, then it's likely not that far away from being priced in perfection. All considered, there's the big resistance ahead for S&P500 around 4545(right shoulder somewhat lower than left shoulder), which very likely shall present a good short opportunity, until middle/late April or early May when the re-opening trade coming into play. Here's part of Wednesday's commentary：【At present, the left shoulder and the big header have completed, and there is a high probability that the right shoulder will start to form (short-term oversold technical rebound). It's not that prudent to expect a very strong rebound, and when that happens, it will present a good opportunity to sell into or going short, as very likely we haven't seen the rock solid bottom yet，which could be around 4000 for S&P500 in the first half, after considering the Pendulum Effect – momentum to the downside】.

The above was posted @10:30AM, Jan 28th, Friday (SF time)

II、Firm belief against hyper-speculative ARKK、MEME & SPAC, great hedge to value investing, and swing trading

On late night of November 9th, right when SARK went debut，I reposted the above interview “Why Matthew Tuttle is Betting against Cathie Wood” in 【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】 WeChat group, as I have been eagerly looking for the best vehicle to short ARKK while minimizing the risk. At that time, I strongly believed that, the very fancy story telling names with way high PE ratios, or even incurring losses, or core logic has deteriorated meaningfully, such as most components within Cathie Wood's ARKK or its cousin ETFs and the very similar type as MEME (GME/AMC/HOOD)、SPAC style，will very likely be the first a few groups of stocks to take the biggest hit when sticky high inflation will force the Fed have no choice but to withdraw the very accommodative monetary policies, then higher risk premium is a must, thus such strategy shall present a very good hedge to value investing, especially in an environment when defensive strategy will be the key, yet even if a portfolio mainly focus on the careful selection of value stocks (high free cash flow ratio, high ROE, high dividend rate, low PE, low PB), the evitable Fed policy shift toward tightening will for sure led to a sharp rise in market volatility and earnings multiple contraction, especially considering the stretched valuation of quite some sectors and subsectors.

During the late November and early December Omicron burst pretty much all over the world, I made some pretty good calls，such as, in the morning of Nov 30th, I sent the following reminder to 【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】 WeChat group：【The S&P500 is currently at 4572.76, which isn't that far away from the short-term (before mid-December) correction target range [4500-4550]. The short-term correction for US major indices may not be that big, as the mega-cap tech stocks with very big weighting likely continue to hold up relatively well in the near future, and will take the leadership role in the likely final parabolic move (please refer to the huge move for Kweichow Moutai SH:600519 during the short period before the Spring Festival and the first trading day after). Though after that, most of these mega cap tech will likely turn down, following the bearish step of Russell 2000 that just fell below its 200-day moving average】.

And the next post was sent near the market close on December 1^st：【BTW, many stocks in the small and mid-cap Russell 2000 have the characteristics of overhype sky high valuations similar to most components of ARKK and its cousins. Russell 2000 has fallen by more than 12% since its peak on November 8th, but looks like it is technically oversold now, though the very likely short-term oversold rebound cannot reverse its mid-term downtrend. Cathie Wood's ARKK is even worse. The S&P500 is currently at 4544.73, which has slipped to the shorter-term (before mid-December) correction target range of (4500-4550) mentioned two or three times here. Short positions better being closed in batches, in order to short the likely rally later on again.】

Note: Shortly after, on December 3^rd, S&P500 did reach the very short-term bottom of 4495.12, and then started a strong year-end rally. BTW, mid-December is the FOMC meeting time and the subsequent Powell’s press conference, and indeed there was a big rally on Dec 15^th.

Before the market open on January 7th, the MEME cheerleader GameStop (GME) soared around 22% on its involvement in NFT. At that time, I warned, “very speculative, a trap for speculators. It just provides a much better shorting opportunity” and added, “after the inflation has been above 5% for several months, it is rather reasonable to go short on rallies on stocks being pumped up big time regardless of the fundamentals”. The opening of GME near $160 in that morning was indeed a great opportunity for short-selling through stock or options. The probability of its NFT plan being “dead on arrival” is very high. It has now dropped below $100, and it is still not optimistic in the medium and long term. 

On Tuesday, January 25^th, after the market close, I warned that，“It's very difficult to predict the medium and long term prospective for Tesla（TSLA）, but short-term, it may drop another 20-30%”. This paragraph has been posted here several times: 【Under the current overall global trend of tightening liquidity, it's better to look for global deep value to buy at the low (require much more patience and reduced expectations, such as, through selling secured puts to entering a position for the long-term investment at a very likely better price, then apply the DRIP strategy supplemented by routinely selling out of the money covered call), adhere to the long-term investment philosophy of value supplemented by growth, and meanwhile, need to short the rally on the over hyped speculative stocks, and supplemented by hedge and swing trading. The real rate of return of quite some major asset classes may likely be negative this year, especially considering the higher labor costs will pose a big risk to current very high corporate profit margins, and China's pandemic zero-tolerance policy is aggravating concerns about supply-chain disruptions. Looking around now, there are still quite some excesses, with asset price bubbles can be observed in quite some areas. All bubbles will have to be deflated to a certain degree, which does not depend on anyone's will.】 Note: the original is written in Chinese, which was preferred by most group members. So I made the above translation.

III、Slowing growth and earnings multiple contraction

The above 5 screen shots were the posts dated Dec 16^th、19^th and 21^th respectively in 【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】 WeChat group, and so far, quite some of my worries have become true or very close, such as：1）very sticky high inflation；2）considering some structural factors, such as the wealth effect of the bubbles, baby boomer's pending retirement, pandemic's effects on average Joe's behavior etc., thus it is very unlikely that there would be much further improvements in the employment（quite inflationary labor shortage）；3）Powell's hint yesterday-December 15 during the press conference could be very likely just a temporarily placebo… very hard to muddle through the muddy waters ahead… with growth slow down meaningfully，very high profit margin to be squeezed somewhat and anti-monopoly policies likely looming；4）revaluation is a sure thing；5）for the once red hot SAAS sector, among the top three, two already slow down very meaningfully, except Microsoft, but its PEG ratio? 6）curbing inflation has become the most important political task；7）the Fed and Powell's projections of future growth, employment and inflation will be likely mission impossible；8）valuation will be the most crucial factor more and more portfolio managers watching now, with growth harder to come by；9）Most big guys in high-tech and consumer staples etc. have been priced in near perfection（with partial similarities to the Nifty Fifty in the early seventies, which didn't end up well at all）. Now, with US household's equity holdings topping the dot-com peak (wealth effect at the top), the huge virtual economy has made the biggest contribution in powering the growth of the mainly consumption driven economy. With the Fed painted itself into the corner, we are in uncharted water now；10）Recently, I warned a couple of times that good caution should be needed when S&P 500 was around 4700, especially toward the very fancy story telling names with way high PE ratios, or even incurring heavy losses, or core logic has deteriorated meaningfully, such as most components within Cathie Wood's ARKK or its cousin ETFs and the very similar type as MEME style.

IV、Issued Quantitative Tightening warnings right at the top on Jan 4th, 2022

On January 4^th，2022，S&P500 reached another intra-day all-time high of 4818.62. That afternoon, I posted the following warning in 【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】 WeChat group，which is absolutely an alarming news related with Quantitative Tightening：Following the decision of the FOMC meeting in December to reduce bond purchases by $30 billion a month from January, according to the latest news from the Wall Street Journal, Fed officials have begun planning how and when to scale back their $8.76 trillion portfolio. On Wednesday, the Fed's FOMC will release the minutes of its December monetary policy meeting, which may mean that the Fed will show a faster tightening policy.

After some research, I issued the following warning：【Though S&P500 made all-time intra-day high today, but no matter whether it belongs to the five tech giants FAAMGs, or the seven tech giants TFAANMG, all dropped somewhat, thus at least in short-term, it isn't optimistic at all. The second-tier、small and medium-cap extremely high multiple fancy growth stocks pretty much all have showed noticeably lagging behind performance, such as Cathie Wood's ARKK and most stocks within its cousin ETFs, as well as MEME stocks】.

V、Noticeable China's growth slow down

1、Model portfolio of 2021

Translation of the above Dec 9th, 2021 post：【The above is the performance of the “2021 Selected Staged Portfolio” and its yield curve so far for 2021，with YTD return of 32.94% (assuming all positions remain unchanged throughout the year, the same initial amount of investment for each stocks, and dividend reinvestment), it is clear that the recent MACD and volume/price has diverged, thus it's a good time to take the profit and run. The performance of this model portfolio has been posted quite a few times in the group (please also see several places in my WeChat Moments). The name of the “Staged portfolio” implies that, some swing trading have been quite necessary in order to achieve better performance, and I did suggest a few times that “swing trading, timely hedging and relatively appropriate asset allocation have been quite important”】.

2、Strongly against going long on Jan 1, 2022 and Recommended Hedging

On Jan 1st, 2022, I was strongly against going long on A shares, mainly for the following reasons：1）The Shanghai composite closed 2021 at 3639.78, and overall, it's not cheap at all，especially when comparing to the badly beaten down shares listed in HK exchange (Please refer to the AH premium rate, currently at 147.01, not far from the all-time high)；2、though at present, these multiple monetary easing measures are likely not big enough to have material impacts, and also it does take some time for these to feed through to small businesses and consumers, of whom quite some may lack enough confidence to borrow more as most of them have the psychology of buying while the price is going up not going down. Considering the explicit and implicit local government debts are extremely huge and inefficient, and there have been few not that bad quality projects to be deployed; the much higher debts due both internally and externally in Q1 and Q2 2022 are very urgent to handle；plus China's zero-tolerance approach toward COVID-19 may incur some unexpected issues during the global gradually re-opening stage. Obviously, the short-term strength of the capital market alone cannot solve the chronic ailment of the comparatively weak consumption. Enthusiasm for idling funds and playing the game of drumming and passing flowers is very harmful, which isn't supported by policies centered on maintaining stability. Thus, lowering expectations greatly, be much more patient, and adopt the strategy of only buying on the panics while selling & hedging on the rallies, shall be more worthy of advocacy. And I went on to warn that, the Shanghai Composite Index still has a good chance to drop to 3480, if not lower. It would be wiser to adopt multiple hedging strategies.

VI、Review middle September 2021 article of early warnings for 2022

Note: Because of the title length limitation, the full title “US stock market Downtrend in September and October is a rehearsal of greater risk next year, the short-term and forward looking of commodity futures and related cyclical sectors” was trimmed to《Downtrend in September is a rehearsal of greater risk next year》.​It's the translation version of《美股9、10月份调整是明年更大风险预演，资源期货与相关周期板块的短期与未来》，which was published on September 18, 2021. Please click the respective titles to review, which mainly contains:

the market analysis, predictions and strategies posted in【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】WeChat group on September 6, 8 and mid-September (all can be found in my WeChat moments as well): 1) Global stagflation risk is rising, US stock market downtrend in September and October is a rehearsal of greater risk next year. On Sep 6^th, I mentioned “Regarding the US equity markets, structural overvaluation is very obvious. Within the next two months, there will be a correction for the main indices, though US markets will still make record highs by the year end. However, quite higher volatility is very likely next year, accompanied by big swings. When the Fed, the Treasury department and the White House act improperly, US stock markets would have the risk of entering a bear market within two years, with the occurrence of some kind of stagflation”, and on Sep 11^th, I mentioned, “total 6% correction from its high on August 16^th”. 2) The so called “black gold” raw and semi-raw material related cyclical sectors in A shares are overhyped; short selling the rallies on coking coal、coke、iron ore、rebar and casino stocks; ESG investment philosophy. 3）The essential internal causes of high risk in US stocks, CAPE ratio, value investment and reverse thinking. 4) Review earlier warnings on some US listed Chinese stocks in 2020 and early 2021, warnings on China Evergrande and Evergrande Automotive at the end of May 2021, the short-term and future prospective of China real estate and related industries. The “Lehman moment” alike disorderly liquidation is absolutely not allowed in the short term, and there will be some policy relaxations, overt or covert, such as the easing on credits and mortgage availability.

Note：All screen shots are from【Swing Trading、Quantitative Strategy、Short Hedging and Asset Allocation】WeChat group.