Trading & Investing in the Relief Rally - Part II

In a previous article, i outlined what I believed was the most likely path and price target for the current relief rally.  I wrote:

"I would expect 2 different paths into this range, ultimately targeting 275.  Either we charge right into that area (as it seems like we have for the past 3 days), or my more preferred case (as depicted with the black arrows), we pause below (where we are today) before breaking out into the box above."   

So far, this has played out shockingly accurate missing 275 by mere pennies.  However, in fairness, this all happened a lot faster than I expected with a lot more gaps.

Now what?

I'm still believe that the Lower for Longer (L scenario) outweighs the U scenario 2:1.  In truth, it doesn't really matter, as both scenarios suggest some weakness in the near term which means getting more defensive and raising capital in the resistance zone.  From a valuation perspective, the S&P at about 2750 implies about a 16 forward PE (before major estimate cuts) and is not cheap.

Over the next few weeks I'm expecting a lot of choppy trading designed to frustrate both longs are shorts - probably more gaps and sharp end of day moves.  Personally, you won't find be buying on sharp up days, nor selling on sharp down days.  I continue to believe the best way to navigate this market is to continue to high grade your portfolio, and hedge (sell something or short an index) as needed.  The primary reason for doing this, is that it will ultimately lead you being generally on the correct path, regardless of a L or U scenario.

While I currently favour the L scenario, I have to accept that the government does not.  I suppose its not that much different of the government response to Covid-19.  Basically, the government continues to do more, until the curve is bent - or in this case, until the recession is halted.  And this is a playbook they are familiar with, from the 08/09 financial crisis.

1. Mnuchin Seeks Another $250 Billion For Small Business Stimulus Loan Program, Senate To Vote On Thursday
2. The Fed will start buying debt backed by emergency small-business loans — giving banks more leeway to offer critical aid

In terms of trading/investing, its more of the same.  Reduce exposure (or beta via hedges) in the resistance zone, and add to quality names lower.  Jettison anything directly impacted by Covid-19.  While it may be enticing to trade in retail, travel and leisure - these are purely trades at best.  As long as there is a chance their equity can be wiped out, it's something I'm not personally interested in.

Some things I consider for this next phase in this relief rally (or conclusion thereof) include:

1. Earnings:  Yes, earnings season is upon us, and I'm not expecting any good news.  At best, guidance is pulled.  "beat and raises" will be non-existant.  At worse - a lot of estimate cuts.
2. Economic news flow:  We are going to get more unemployment figures, and declining economic indicies.
3. Covid-19 news:  We'll be seeing some areas like NY begin to bend the curve, but deaths will still be rising.  Additionally, we can expect other cities begin their climb on the curve.  Fortunately, these areas should have the benefit of additional supplies that can be diverted to them.

None of these, I expect to be bullish.

With that said, its worth stating that my own strategy emphasizes capital preservation.  If I can 'dodge' another major decline, and maintain market exposure when the market eventually resumes its upward trend, I would consider that a success.

Subscribe to receive by Email

Risk Manager Jeff