There is little doubt in my mind that the US and China are headed toward a serious one-on-one conflict at some point in the coming years. What started as a trade war has become a complete pivot away from globalism adding to tensions that already existed over the South China Sea, Hong Kong and Taiwan, not to mention a proxy-war within the Russia-Ukraine conflict. And with a noticeable military buildup by both countries in the Pacific and China warning its soldiers to prepare to take Taiwan in 2027, surely we are on the precipice of something uncomfortable.
Of course just as with the prediction of recessions or big market corrections, the timing of such events is quite difficult to predict, even with so many bad omens already presenting themselves.
Let’s dig in.
In this issue
SIGNIFICANT OBSERVATIONS
A Spy in our Midst
2021 All Over Again?
Labor Market Surprise
Fed Speak
Consumer Crumbles
Consumer Price Index
MARKET OUTLOOK
Macro Summary
Favorite Stocks
Additional Charts
MY PORTFOLIO
Portfolio Objective
Asset Allocation
Current Holdings & Performance
ETF-only Alternative
SIGNIFICANT OBSERVATIONS
A SPY IN OUR MIDST
At first I did not pay much attention to the news of a balloon floating over the western US, but I knew I had to dig in much deeper when I read that on Feb 4 a US Air Force F-22 Raptor blasted the object with a AIM-9X sidewinder missile just 6 miles off the South Carolina coast.
On Wednesday Feb 8, a team of special Navy divers has recovered remnants of a Chinese surveillance balloon from the depths of the Atlantic Ocean. Surface recovery ships are being used to scoop up the debris while underwater drones locate debris fields for divers. Ahead of the recovery effort, Gen. Glen VanHerck, commander of US Northern Command and North American Aerospace Defense Command, told reporters the balloon was massive, measuring 200 feet tall with a payload weighing nearly a ton.
Lawmakers have voiced concern that the 'weather balloon' was a spy balloon that could transmit information back to Beijing. Answers to those questions could come as soon as investigators are finished analyzing the debris.
While the specific intention of floating the balloon is anyone’s guess, I have to think there is much more here than meets the eye.
Obviously the Chinese government is not foolish enough to think they could float an object coast-to-coast across the US without being spotted by the US military or its citizens. And if China wants to surveil America they can easily rely on their satellites or pay private commercial operators like they are doing in Ukraine. China clearly marked the flying object as their own so there would be no doubt as to where it came from, and they clearly wanted US citizens to see it.
As
wrote in her Feb 6 post:The whole point of [US citizens] moving to Montana and Wyoming is to get away from government authorities. The zeitgeist of these Western states is one of militant and armed independence from the outside world. This is the part of America that kicked Liz Cheney out of office for being too soft a Republican. The folks in Wyoming and Montana don’t want to depend on Washington to defend them. They certainly don’t take kindly to having a foreign power hovering over their land.
The events that followed over the weekend of Feb 10-12 with multiple “UFOs” being shot out of the sky was nothing more than manufactured nonsense from the US government. I’m guessing as a distraction from some other world event that most ended up missing as a result. So there’s that.
2021 ALL OVER AGAIN?
As discussed in the “On the Margin” podcast of Feb 1:
Markets started the new year with a strong rally seeing gains of around 7% in the S&P 500. Many anticipated a hawkish press conference from Jerome Powell in a bid to tighten financial conditions and ease some of the "animal spirits" that we saw throughout 2021. Jim [Bianco] makes just that comparison. This market is showing signs of 2021 with the most speculative and highest beta names rallying the most.
The latest bear market rally actually began in mid-October and so has lasted for several months now. Of course the big difference between 2023 and 2021 is that we no longer have monetary and fiscal stimulus pumping money into risk assets. So my bet is this year will not be a repeat of 2021; in fact it may look more like 2022 for much of the year. We shall see.
My plan is to simply watch and trade the charts as always, keeping in mind my macro outlook as summarized later in this article.
LABOR MARKET SURPRISE
January’s U.S. jobs report was stunningly good — a big surprise as Non-farm payrolls increased by 517,000 for the month, shattering analysts’ estimate of 187,000. Unemployment rate fell to 3.4%, the lowest since May 1969.
While stocks cheered the job report for several hours (see chart in section below), there are two facts to keep in mind:
A strong jobs report will only make the FOMC more hawkish on suppressing inflation and stocks
The labor market is a lagging indicator of economic activity, and history has shown time and time again that unemployment is typically at its lowest just before the economy starts to roll over, with unemployment generally highest as a recession is coming to an end.
In the days ahead we will see if that jobs number and Powell’s comments below marked the top of the latest rally in stock prices.
FED SPEAK
Feb 1: The FOMC decision to raise their target interest rate by 25 basis points (0.25%) was well anticipated by markets. But during Powell’s remarks at the press conference, he was far more dovish than expected and with that the S&P 500 moved up nearly 3% intraday.
Feb 7: Jerome Powell then spoke during a televised interview and reiterated his positions of Feb 1, albeit in a less formal way:
Well, we say that we're using our tools to get there over time. If you look at our forecasts, we expect 2023 to be a year of significant declines in inflation. And it's actually our job to make sure that's the case. But I would tell you that, you know, with inflation headline, PCE inflation is running about 5%. This is on a 12- month basis. Core is running at 4.4%. My guess is it will take certainly into not just this year but next year to get down close to 2%.
In the midst of the two events above, the US stock indexes whipsawed in epic fashion, particularly on Feb 7 when the SPY moved ~2.2% in under 2 hours.
CONSUMER CRUMBLES
ZeroHedge Jan 31: Demand and output for cardboard boxes and other packaging material fell sharply in the fourth quarter of 2022, according to data released by the American Forest & Paper Association and Fibre Box Association. It’s the latest indicator that consumer demand is eroding following the pandemic. Dwindling savings, inflation, rising interest rates and fears of a recession may all be swaying consumers to spend less.
As
noted:Consumers apparently are frightened to death by those 2023 recession forecasts and have steadily been saving more of each month’s income since September last year. Personal saving as a percentage of disposable personal income was 2.5% in September and is now 3.4% in December 2022.
CONSUMER PRICE INDEX
As reported by CNBC on Feb 14:
High inflation has followed the U.S. economy into 2023, as consumers continued to see high prices in January. Inflation rose 0.5% for the month and 6.4% over the past 12 months, according to consumer price index data released by the U.S. Bureau of Labor Statistics on Tuesday. Both results were higher than some economists’ expectations, which had predicted 0.4% for the month and 6.2% year over year.
This is another indication that the FOMC may have to stay hawkish for longer.
MARKET OUTLOOK
MACRO SUMMARY
My macro outlook on the markets has not materially changed since my last writing, though with the passing of time, I have a little more clarity as to the timing of events in the short term. Below is a summary:
The rally in stocks that began on Oct 13, 2022 is likely coming to an end with a topping pattern that began to develop on Feb 2. I continue to believe that US stock indexes will head lower over the course of 2023 based on my technical analysis of the charts, the labor market, the consumer, and the Fed themselves basically telling us this is what they want.
Currently I expect to see another trade-able low in stocks somewhere around late March to early April, and possibly a retest and a more investable low somewhere in September.
On the back of what will eventually be a slightly more dovish Fed (maybe not lower rates, but a less-hawkish tone at least) and a potential washout of bullish sentiment, I expect both stocks and commodities to begin a strong multi-month cyclical bull market rally that may last into mid-2024.
However, my current view is that by Q4 2024, US presidential election cycle may look a lot like the presidential cycle of 2008 where the economy and stock market both tanked, ushering US citizen demand for new leadership.
I believe 2021 was just the first year of what is likely to be a multi-year secular bear market that will be characterized by wild swings in both directions, creating a lot of opportunity for the active investor.
I believe the best portfolio for this sort of environment is comprised of a diversified collection of high-quality dividend-paying stocks, select emerging market ETFs, US equity index longs and shorts, precious metals, and at certain times a substantial amount of cash or cash equivalents.
For more details around my market outlook, check out my Feb 1 post.
A FEW OF MY FAVORITE STOCKS
At the request of many of my readers, I am going to be showcasing a few of my favorite stocks with each post going forward to give my readers more context around the construction of my portfolio and my current views on equities.
While I do expect most stocks to pull back in the weeks or months ahead, I am a big fan of all 50 stocks held in my portfolio within the context of a group of holdings, but not necessarily for a swing trade on any individual stock.
In the current market environment you’ll want to be careful with any stock whose price action has recently demonstrated excessive exuberance — most stocks of that sort are likely due for a big pullback.
I expect my portfolio to continue to perform well in the current market environment and I have selected a few of my holdings to showcase below.
Enterprise Products Partners L.P. (EPD, Oil & Gas Midstream)
Enterprise Products Partners provides midstream energy services to producers and consumers of natural gas, natural gas liquids, crude oil, petrochemicals, and refined products. The company operates through four segments: NGL Pipelines & Services, Crude Oil Pipelines & Services, Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services. Source: Finviz
Dividend yield: 4.9% | Forward P/E: 13.22
CFRA Analyst: Our opinion is Buy. EPD has strategically- located assets, diverse cash flows, and organic growth potential, particularly with regard to Gulf Coast gas and liquids export markets. We see EPD as a major facilitator for exports of crude oil, NGLs, and natural gas via hubs such as the Houston Ship Channel. Although we think NGL prices may decline a bit, we do not currently see cause for a major relapse, given high crude oil prices. We note that, as of late 2022, U.S. spot NGL prices were declining but remained above historical average.
Though potentially due for a short-term pull-back, particularly if oil and the indexes pull back, when we view 10 years of chart data, we see that the stock is trading very near its long-term mean. This sort of position should add stability to my portfolio while generating solid income. My other favored holdings in the oil and gas midstream sector are MPLX, ET, OVV, DCP, TRGP.
Vale S.A (VALE, Materials Mining)
Vale produces and sells iron ore and iron ore pellets for use as raw materials in steelmaking in Brazil and internationally. The company operates through Ferrous Minerals and Base Metals segments. The Ferrous Minerals segment produces and extracts iron ore and pellets, manganese, ferroalloys, and other ferrous products; and provides related logistic services. The Base Metals segment produces and extracts nickel and its by-products, such as gold, silver, cobalt, precious metals and others, as well as copper. Source: Finviz
Dividend yield: 8.8% | Forward P/E: 6.40
CFRA Analyst: Our Buy opinion is based on Vale’s impressive free cash flow profile. While we recognize the ongoing risks related to Brumadinho liabilities, we also acknowledge Vale for taking appropriate action to mitigate future risk of dam ruptures. We think Vale’s new management team is laser- focused on improving safety as its number one priority. Vale’s balance sheet is strong and we think it has entered a period of returning significantly more cash to shareholders. Vale’s strong dividend has been reinstated and VALE is also executing a share buyback program. We think VALE should trade at a higher multiple of earnings.
While Vale has recently pulled back in price along with commodities and most stocks, the good news is the stock has worked off the excessive exuberance it saw during the ‘post-pandemic reopening’. And while a recession may dampen demand for commodities, I believe that the world is far behind in terms of materials production based on current global leader expectations for a carbon-neutral world. I discuss this in much more detail in my “Of Earth and Isotopes” post.
My other favored holdings in the materials mining sector are NEM, TECK, FCX, RIO, and URNM which is an ETF.
Entergy Corporation (ETR, Electric Utility)
Entergy engages in the production and retail distribution of electricity in the US. The company operates in two segments, Utility and Entergy Wholesale Commodities. The Utility segment generates, transmits, distributes, and sells electric power in portions of Arkansas, Louisiana, Mississippi, and Texas, including the City of New Orleans; and distributes natural gas. The Entergy Wholesale Commodities segment engages in the ownership, operation, and decommissioning of nuclear power plants; and ownership of interests in non-nuclear power plants that sell electric power to wholesale customers, as well as provides services to other nuclear power plant owners. Source: Finviz
Dividend yield: 4.1% | Forward P/E: 15.4
CFRA Analyst: We recently upgraded our view to Buy from Hold. With a lower risk profile than it has historically had following ETR’s exit from the merchant nuclear power business, combined with competitive EPS (~6.6%) and dividend (6.2%) three-year CAGR expectations at or above peers, we think shares of ETR are trading far enough below fair value to merit an upgrade. Although ETR operates under several regulatory regimes deemed by Regulatory Research Associates to be “average” from an investor standpoint, we think the recent approval of nearly $1.5b in storm-related cost recoveries (through issuance of securitization bonds) in Louisiana was a positive development. ETR also sees longer-term benefits from the recently passed Inflation Reduction Act, particularly with regard to tax credits for clean hydrogen investments. ETR’s TX rate case ($131m rate increase, 10.8% authorized ROE requested) remains undecided.
From a technical perspective, ETR has worked off the exuberance of 2019 and the selloff from the crash of 2020. The stock now trades at the bottom of a parallel channel that has been in place since March 2020. Certainly the stock could trade lower from here, but all things considered I like where this one sits, both technically and fundamentally.
My other favored holdings in the Utilities sector are NRG, NI, VST, EVRG.
If you would like additional detail around these or any of my other holdings, please comment or drop me a line at Info@FiNiche.net. I will dive into more of my holdings in my next post.
ADDITIONAL CHARTS
QQQ
The two strongest rallies we have seen in the NASDAQ Comp since March 2022 are shown in the equal-size boxes in the chart below. In technical terms, we can call Box #2 a ‘measured move’ as the boxes are of the same height. On Feb 2, this was my first indication that the current rally had topped.
WTI CRUDE OIL
Oil is still trading in a range between $70-$80/bbl as it continues to work off the overbought condition that stemmed from the Russia-Ukraine conflict. While I still think the oil price may pull back to its mean ~$62 at some point this year, I feel good about the oil & gas midstream holdings in my portfolio.
GOLD
Gold continues to trade within the parallel channel shown in the chart below. As I’ve mentioned previously most of my precious metals holdings are in physical form, though I do hold a trading position in my portfolio which you can see later in the article. I expect to add to my current position on a pullback in the gold price to ~$1805/oz.
MEXICO STOCKS (EWW)
With a US pivot away from globalism I continue to like the Mexico stock market. EWW is one of my emerging market holdings which is still trading in the neighborhood of its mean price going back to 2007 and pays a decent dividend of ~3.1%. In the short term I might expect the price to pull back to the lower parallel channel trend line, at which point I may add to my EWW position.
US TREASURIES (LONG-DATED)
The US treasury market continues to be difficult to trade with the yield curve so inverted. I may look to add to my small position in TLT should I close my equity-short positions at a trade-able bottom in stocks. At present time I’m waiting to see if TLT completes a breakout or breakdown based on the trend-lines in the chart below.
BITCOIN
Despite the recent rise to ~24.5k USD/BTC, I still expect the price of Bitcoin to drop as the equity market sells-off over the coming weeks and months. I do not own any crypto currency at this time, but may look to open a position in BTC should the price drop below 10k.
And with that, let’s dig into my Portfolio!
The below portion of this newsletter is still being offered free of charge to all my readers. Please see my About page for subscription tiers coming March 1.
MY PORTFOLIO
PORTFOLIO OBJECTIVE
My portfolio is designed for a specific portion of my wealth and is constructed with a total return profile, seeking capital appreciation through both dividend income and growth. My portfolio has a very strong bias toward risk management and capital preservation with the goal of providing superior risk-adjusted returns.
ASSET ALLOCATION
Within my portfolio there are two primary tranches:
Core Equities tranche, which I believe will deliver solid growth and income over the long term.
Opportunistic tranche, which I used for risk management and alpha generation as may be appropriate given prevailing market conditions.
To better understand my model portfolio and investing approach, I encourage you to refer back to both my Introduction and Opportunistic Tranche articles.
My current allocation is shown in the chart below.
CURRENT HOLDINGS & PERFORMANCE
I detail my current holdings and performance metrics in my 1st-of-the-month Big Portfolio Refresh, the next of which will be published March 1.
ETF-ONLY ALTERNATIVE
If your preference is to avoid individual stocks and build an all-ETF portfolio, that may work well for you also. There is a big world of ETFs available out there and I know many people who have successfully constructed excellent portfolios in this manner.
If you would like help to better understand the ETF landscape please either seek the advice of a professional of your choice and/or visit my About page to contact me for more information.
Below is one version of an ETF-only portfolio intended to be similar-in-spirit to my portfolio, but of course this is far from an exact replica of holdings. However, this portfolio does contain similar proportions of sector and asset allocations as well as similar net-long exposure.
If you do not intend to be an active trader, simply skip the SDS (short) position and keep that money in cash. Nothing wrong with that at all.
IN CLOSING
This article is part of my mid-month ‘Market Minutes’ series and is a supplement to my first-of-the-month Big Portfolio Refresh. My intent here is to provide timely updates around significant market-moving events and portfolio allocation, as well as a few educational nuggets.
I encourage you to go back and read my Feb 1 post for my full macro view on the markets — there is a lot in there and you’ll want to keep all of it in mind as we move along.
Let’s keep the conversation going! Please comment, share and join my Chat. For more information about the cadence of my writings and to contact me directly please visit my About page.
Thanks Julian I always appreciate your insight. When the markets turn down, it happens very quickly. Wait for it…
Thanks for the mid-month update. Always look forward to your coverage and views across different sectors. Agree that these are precarious times from a geopolitical point of view, for better or worse, markets meanwhile still seem largely unaffected.