HomeMost PopularThe S&P 500: Adjusting My Strategy and Booking Profits on Short Positions

The S&P 500: Adjusting My Strategy and Booking Profits on Short Positions

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Exiting Short Positions

As discussed previously, I had a modest short position on the S&P 500 for the duration of 2023, starting from January 1st. Specifically, I held short Dec call options with a strike price of 4400. These options are now out of the money, and given the time expiration, I have decided to exit this short position with profits.

Here is the chart of the SPX Dec 4400 call from January 2023:

I viewed this short position as an appropriate strategy for 2023 within my tactical framework. While the market did experience a significant rise during the first half of 2023, I remained convinced that it was a β€œbear market rally” and that it would reverse in due course.

Specifically, after the debt-ceiling resolution in June, the S&P 500 broke a key resistance level on the long-term chart, led by the megatech AI stocks. However, the rally ended as 10-year yields started rising, triggered by Japan’s monetary policy adjustments and the subsequent rise in JGB yields.

This situation raised significant concerns regarding the supply and demand for US Treasury Bonds, with negative implications for the stock market. Consequently, the SP500 sold off, retracing back to the 4200 level, which marked the breakout point in July.

Therefore, I am modifying my tactical positioning in the S&P 500. I have exited the short calls and am now planning for the next move.

Maintaining a Bearish Outlook

I have previously explained my strategic positioning strategy for the stock market, which involves a default long position unless specific risks emerge. These risks include a significant liquidity shock, imminent recession, or credit crunch.

  1. A liquidity shock resulting from expectations of aggressive monetary policy tightening or other sources can lead to a sell-off driven by PE multiple contraction, particularly in an overvalued market.
  2. The risk of an imminent recession, with sharp downgrades in earnings, can also prompt a sell-off in the stock market.
  3. The risk of a credit crunch or forced selling due to a spike in credit risk, as well as systematically important bankruptcies, is another factor that could impact the stock market.

Considering the current situation, there are several factors to take into account. First, the Federal Reserve’s induced liquidity selloff occurred in 2022, and additional rate hikes are expected in 2023. Secondly, current earnings expectations for the S&P 500 are overly optimistic for 2024, assuming an approximately 11% EPS growth without anticipating a recession. However, if a recession were to occur, earnings would need to be significantly downgraded. Given the inverted yield curve and recent bear steepening of the yield curve, a recession appears highly likely. As a result, I maintain a bearish outlook and believe that S&P500 fair value is around 2800 in a recessionary environment.

Additionally, credit spreads are tight, and with fiscal deficits, supply/demand issues with US Treasuries, concerns surrounding Commercial Real Estate and Regional Banks, and the slowing Chinese economy, there is a likelihood of a credit crunch, although it may not be imminent. Therefore, a potential next leg down in the S&P 500 would likely be due to an imminent recession and earnings downgrade, particularly for big tech companies such as Apple.

However, my original short thesis from the end of 2022, which predicted an imminent recession, has been delayed. The data towards the end of 2022 pointed towards an impending recession, but the post-COVID reopening in 2023 resulted in a boom in consumer spending. While there are concerns about the consumer being tapped out and the potential impact of student loan repayments, the strong labor market continues to show resilience. It is possible for a full-employment recession to occur, but the timing remains uncertain.

Increasing Short Positions

I previously mentioned that I would short more aggressively once the S&P 500 breaks the 4200 level, which also serves as the 100-day moving average support on the 5-year chart. This level may trigger a significant number of stop-loss orders below 4200.

The fundamental trigger for the more aggressive short position is the anticipated 2024 earnings downgrade and early evidence of a recession. This would align with the recessionary sell-off within my framework.

Potential End-of-Year Rally?

However, it is important to consider the possibility of an end-of-year rally, which could propel the market towards new highs. This rally could be triggered by a delayed recession, with the potential for continued consumer spending extending into the holiday season. Additionally, a strong labor market report increases the probability of sustained growth.

Meanwhile, the Federal Reserve is expected to conclude its tightening cycle soon, with potential for one more hike or even two, transitioning to a stance of holding rates and tightening as inflation falls. This shift is occurring amidst ongoing economic growth.

The resolution of events such as the UAW strike and approval of the fiscal budget before the November 17th deadline could also contribute to a positive resolution and potentially drive the end-of-year rally.

Implications

Whether the recessionary sell-off occurs in the near future or a few months from now, it is inevitable. I anticipate the S&P 500 reaching 2800 in the long term. For long-term investors, it may be prudent to consider short-term T-Bills, with yields of approximately 5.5%, and potentially extend the duration to 12 months with an attractive yield of 5.44%. Therefore, strategically speaking, my rating for the S&P 500 remains a sell.

However, tactically, caution is advised, as timing the recessionary sell-off has proven challenging due to delays. In the meantime, it is important to acknowledge the possibility of an end-of-year rally. Consequently, my tactical rating on the S&P 500 is currently neutral.

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