What an Unbelievable 2023!

Dear Traders,

What an unbelievable start to the year. As I wrote two weeks ago, this could have been the start of the next bull market, that hopefully would last for another 10 years. Only in 2023, according to TradingTerminal.com’s Normalized Market Performance tracking, Nasdaq is up over 17%, IWM 14%, and SPY 9%. Today, Dow Jones’ companies were red, but growth stocks such as IWM and QQQ were rallying hard. What is happening in the market?

First and foremost, the Federal Reserve announced that they are still hopeful for a soft landing, and that will probably pause their aggressive tightening campaign after a few more 0.25% increases. Investors took heart from Jerome Powell’s remarks acknowledging that price pressures have started to ease, sending stocks on a rally and pushing the USD lower. Second, the reported inflation number has come down in the right direction, three times in a row in the last quarter, which we call “three-strike!”.

The National Financial Conditions Index (NFCI) shows a “loosening” of financial conditions, meaning the appetite for risk-taking has gone up, the spread of junk bonds to Treasury Bills has come down, and overall it is an environment of “RISK ON” for investors. I find the NFCI to be very interesting because it very accurately reflects the last few bottoms and highs of the market. The slope of the index is its most important element. If the slope is positive, meaning financial conditions are getting tighter, then the market goes lower. If the slope is negative, it means that the financial market is getting looser, and then the market goes up.

But what is the rally sustaining? Over the last few months, we’ve seen data that’s more or less consistent with the “soft landing” outcome. Inflation has come down, even as the unemployment rate has fallen to a 50-year low. We thus know that at least over some period of time it’s possible for these two trends to coexist. But there’s still doubt at the Fed that it can work in theory. To not enter a recession, you need growth to happen. And companies cannot grow without hiring more staff, and in such a tight labor market, the only way companies can grow is to increase the acceleration of salaries and wages, and that will translate into more inflation. That is why many investors still believe that a recession is the only way to get to price stability, and we will have to engineer it to happen sooner rather than later.

But another issue is stagflation. What if inflation stays at 4-5%, and the job market stays tight, and interest rates stay at 4.5%? Then there are only two options for the Fed. They either have to accept a 4% inflation rate (which is double their 2% target), or they have to force an engineered recession to send the unemployment numbers up.

Therefore, all eyes are now on tomorrow’s job market report (Friday, February 3). The Fed is not declaring “mission accomplished” by any means at all. Powell expressed hope that inflation can be vanquished without a “significant” rise in the unemployment rate (instead, only a “modest”rise). A big question though is whether a modest rise in unemployment is even possible.

Accordingly, keep an eye on the job market.

Big tech companies have reported their earnings and, as expected, META, Apple, Amazon, and Google had disappointing news for investors. Before the earnings release, Ardi and I did a small risk reversal on Apple earnings and unfortunately have lost money as I write this newsletter.

The calls I sold on Tesla last week for $210 and $220 were amazing and worked well, delivering a nice profit of over $50,000. Amazon puts in March should be fine even though Amazon is still trading lower in the post-market.

Now that there is more demand for options trading in our community, Jarad and Megan have started a new chatroom dedicated strictly to options. Check out their room on Mondays, Wednesdays, and Fridays.

To your success,
Andrew

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