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kennethkohwk

An intermediate bottom in the S&P500 now?

Although no one can 100% predict with accuracy what future stock market movements will look like, good traders need to have a general framework to trade from.


It is far better to use all the data available, and have a rough idea what the markets should do. Then, plan your trades in only certain places to maximize your reward-to-risk ratio in the cash you are wrong. For example, if you think longer term the forces are forcing the stock markets down, then you will wait for the markets to recover upward to a certain level before going short. Or, you will wait much lower for an extended downsize before trying to play for an intermediate rally.


There's an old adage that says BULLS make money, BEARS make money, but HOGs get slaughtered.


It means that to make money you need to have a conviction on where the market is going and trade accordingly. If you are correct, you'll make money. If you are wrong, having the correct entry and risk management will minimize losses. But if a person is double minded all the time, he will likely get whipsawed too much.


However, stocks don't go up or down in a straight line. There are always short, medium and long term variables in play at the same time.


It is common for people to have the correct longer term direction correct, and still not make much money because they get in the market at the worst times, and get whipsawed a couple times because they doubt their thesis when the markets make powerful moves in the other direction.


I will keep this post short because I am supposed to be on a hiatus. I will not go through all of my thought processes, but just enough to make a point.


But in summary, here's what I think today.


1) It's possible we are still in a bear market, with the lows of the markets to be taken lower on the longer term. We have a flattish yield curve. The FED seems to continue to hike interest rates into a recession. Inflation is not tamed yet

Here, the yield curve is flattish, although the 10Y-3M is not... yet.


Here is the framework I am assuming (based on my experience with technical analysis, elliott wave, and how I see money moving through various sectors). Of course it may not happen exactly like this (although I have a good track record in anticipating intermediate bounces), but it just seems more likely that there will be a bounce soon vs no bounce, and it seems likely that on the longer term, new lows will occur before new highs, based on what information I see in the present.



2) However, it's possible for intermediate rallys on the way to the downside.


These intermediate rallys should not be ignored because they can be powerful. The last one took the broad markets up 15% before collapsiing to today. Traders that asked me for advice got in that trade and got out at the moment of short term weakness, making some money in the process.


An important note is this: the above drawing is only a guide. The wave pattern might go higher than what is drawn here. It really depends on if there is actual significant news that might change investor sentiment for a longer term. However, as it stands now, the downside looks to be VERY OVERSOLD and lots of dry powder on the side just waiting for a chance to buy back into the market.


So as a trader, I would position myself to play a bounce, and only after the bounce gets to my target, to consider what the price movement shows to see if it can go further, or if I should take profit already. The most important thing is to know a short to intermediate bounce is ripe and to get in it first, then see how far it goes.


Even for those who are pessimistic for the rest of the year and the next, if you want to position yourself to the downside, you still need to be cognizant of certain points in time where lots of medium term, upside gunpower is accumulated such that a spark, a catalyst might cause a significant short squeeze. That time could be now.


However, taking a long bet in a bearish market is a risky endeavour. And most won't have the stomach to do it.


You need two things:


a) Lots of hints to give you conviction that there is a good chance a recovery is coming.

b) Taking the trade in an advantageous spot such that even if you wrong, you don't lose much.


Downsidewise, a typical average drop in the broad markets during a proper recession is about -37% from the top. Note that as of today, the S&P500 has already dropped by -25%. So, even if the recent low is broken, we are already closer to the end of this bear market based on downside... only -12% more.


On the intermediate side, why could there be an intermediate recovery coming soon? Here are a couple hints:


1a) There are many stocks that have plumetted so much already, they are already trading at recession prices based on valuation. These stocks are like canaries in that they are more sensitive to traders and are smaller cap stocks. Some havecapitulated and are showing signs of accumulation. Here are two examples:


Notice that September plunge?


FRG actually isn't doing that badly at all. They are still quite profitable. But they decreased their guidance a little. They are trading at 6x FW PE and 10% dividend rate. Their debt is manageable at 3x net debt to EBITDA and they plan to reduce it more. This company owns different franchises in the US and has a good track record of good acquisitions that are cash flow rich. I won't go more into details, you can read it here.


Here's another canary, it's a M-REIT. M-REITs are traded by people with itchy trigger fingers. Because in theory, they own lots of leveraged assets, when drastic changes occur in the economy, there might be harsh writedown to their assets, which happened in 2020 during the COVID crash.


I won't go too much into detail into RITM (used to be known as NRZ), but it's trading at a 11% dividend rate, and it's last book value was at $12! RITM is NOT your typical MREIT, but they tend to trade in sympathy with the rest of the MREITS. Now, for context, during the COVID crash, their book value dropped 35%. At $7, the market is discounting a 40% book value drop! This looks overdone considering that RITM has been planning for this higher interest rate environment, it's not like the COVID crash that caught everyone unawares.


The point: some speculative value stocks have already capitulated to recession prices. But, the recession reality isn't fully fleshed out yet.


Next:


1b) The sector that seems to trade with the broad markets are the semi-conductor stocks, like MU, QCOM, NVDA. Semi-conductor stocks tend to turn up at the same time as the market, or even slightly earlier.


Some of the more popular ones have turned up on the short term basis.

Micron's MACD has turned up, finally.


But the rest of the semi-industry hasn't yet... but perhaps it could!

Is Micron a canary, a leading indicator?


2) The Smart Money / Dumb Money sentiment spread is at extreme levels again! Notice every time this happens, it indicates a short term bottom, or an intermediate bottom even in the bear market of 2022.

3) The USD has printed a bearish candle, from the recent overbought region of the RSI. If the USD falls further, especially if the MACD turns downwards because of it, it will be a boost to equities, especially inflation stocks. It looks like it has more to come down or consolidate before it hits the longer term support (blue line). This might coincide with the bounce on the stock market.



4) We are actually on a strong long-term support that many might not realize.

The red line is the support that usually the first time you get there results in a bounce. The only time a bounce didn't happen and the $SPX broke straight through was during the COVID crash in 2020. Even in the 2008 great recession, we got some kind of consolidation.


5) This sets up the great reward-to-risk trade. Since,

- some stocks are already at recession prices (but not the big caps like MSFT).

- smart and dumb money are at extremes.

- stocks like MU (at are on everyone's radar and cyclical) are attempting to turn up.


we have signs that a bounce is possible.


What does possible mean? It means that this point in time is a candidate for a bounce. The bounce may NOT happen, but it might at these levels. Or, not all candidates might have a bounce, but a bounce usually starts from one of these candidate points.


Since we are right on the redline support, this easily becomes our "failure line" or "trading stop-loss" if you want to manage risk on your trade.


Those who are playing for an intermediate bounce, would go long now (and better on certain stocks that are very oversold and are at great valuation, and have the financial flexibility, or optionality to reward shareholders directly), and they can cut their losses if there is a definite close under SPX 3590, which is only 2% lower from where we are now.


In that sense, you are risking 2%, but your potential reward, should the markets cycle higher, is likely 8%+. That's a 4:1 ratio.


Final thoughts:


Once again, at the present moment, I don't see all the signs that we've reached the absolute bottom that might start a multi-year bull run. However, an intermediate bounce is possible. How long the intermediate bounce will last, or even if the intermediate bounce morphs into a longer term move depends on the fundamentals that will reveal more of itself when the time comes. But today, we have to make decisions on incomplete information and only on the partial truths we see in the present.


And, there are still certain things that will spook conventional investors / fund managers. One of which is the flattening yield curves that signals more weakness in the economy and markets. High interest rates reduces end-user demand, and gives companies less opportunities for expansion.



However, we should be on the look out for interemediate bottoms, because they can be explosive (8%+).


THis is also useful for those with a short thesis on the market because you believe we are in the middle of a bear market led by the typical FED rate hikes, because if the market rises by 8%+, it doesn't mean your thesis is moot. In fact, this 8% rise can simply be explained by technical reasons, a mean reversion because the downside has exceeded more than it should at this present moment.


For those who are weary about the tightening rates and uncontrolled inflation, you would consider taking some chips off the table but see if there is a bounce first.


Everyone stay care!


God bless!


PS: Companies that are cash-flow rich, at arguably cheap valuations at today's prices, have financial flexibility either now or soon and have either high insider ownership or buying are:

ET, VST, CROX, FRG. FRG, for example, just okayed a share buyback mandate for $500M over the next few years. It's market cap today is $1B. Their annual cash flows are such that they are willing to buy 50% of their market cap in the next couple years. This looks like it's already at recession prices. Pls do your own research on these stocks in order to know for yourself if you are willing to hold them through a potential recession or not.


Disclaimer: for educational purposes only!


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