THE WAR THAT SAVED THE MARKET

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The market is flying.  Meme stocks are back.  It is good times again. 

But I have not been a big buyer.

Instead, I have taken the opportunity to reduce my positions – particularly in oil – and regroup.

I am not convinced that what we have here is a sustained bull market run.  So I still have a huge cash position, and have been doing mostly…nothing.

Instead, I think this is a market that has lost its roots.

Here’s my thinking (caveat: after making A LOT of money from late 2019 – mid 2021, I have been wrong a lot lately).  A month ago, I was sure that we were on the road to a much larger move down.  The S&P was headed to a 3-handle.  The micro-cap stocks that I work with would have been that much worse. 

Then the Russian invasion of Ukraine—war–happened.

The war changed everything.   But front and center is that it changed the narrative.

The S&P had been falling for two months.  Most stocks had been dumping since the summer.  The narrative accompanying the fall was a world of rising rates and the demise of a 30-year bond bull market.

But then – BOOM!  An about face: war, shortages, fear of escalation.

It was scary.  It IS scary.

But here’s the thing.   This new narrative – war – it follows a whole new set of rules.

These rules aren’t nearly as bad for stocks as endlessly rising rates, particularly for the stocks that had been going down the most.

BUT – and why I am being cautious–the war narrative will be transitory.  Fundamentals – the economy, inflation, the Fed tightening – they will come into play again.

The economy sure looks like it is rolling over to me.  There are an awful lot of headwinds once we get past any moment of triumph.
 

THE NEW WAR NARRATIVE

 
Do you remember that we had sky-high natural gas prices in Europe as far back as November?  I do.
Doesn’t matter.  Natural gas was now up because of the war.

Same with oil, same with coal, corn, soybeans, steel, metals and rates.  Every move up and down was now because of the war.

That laid the seeds for a rally.  A boomer!   A positive development on the war front, any positive development, is now a reason for the market to rally.

Do you really think that unprofitable tech and meme stocks like Gamestop (GME – NASDAQ) could have rallied as the 10-year note took off to 2.5% absent the war?


Source: CNBC

No way!  Rising rates are the sworn enemy of these stocks.

But if rates are rising because of war?  Especially if we are winning?  Bullish!

It is no surprise that the best performers have been those stocks that were shorted the most – meme stocks and unprofitable tech. 

Check out the biggest winners since March 11th (only 11 trading days ago!):

  • Gamestop (GME – NASDAQ) up 143%
  • AMC (AMC – NYSE) up 116%
  • Kodak (KODK – NYSE) up 67%
  • Virgin Galactic (SPCE – NASDAQ) up 44%
  • Tesla (TSLA – NASDAQ) up 43%
  • Bed Bath (BBBY – NYSE) up 37%
  • Beyond Meat (BYND – NASDAQ) up 36%

See a theme?  Former darlings, beaten down for months, now back with a rocket-ship-like rise.
It’s a war rally – driven by the euphoria of winning the war.  Worrying about rates is for another day.
 

CAN THIS GO ON?

 
Because this is a war rally, it is hard to know how far it will go.  We know how far bear market rallies go – they would normally be ending right about now.  War rallies are more uncertain.

But I doubt this is a new bull market.  We almost never see a new bull market led by the winners of the last one.

What’s more, the craziest moves have been in the most heavily shorted stocks.   Short-selling rallies run out of steam when there are no more shorts to cover.

Given the pain, we may be getting there soon.

Morgan Stanley put out an interesting piece this week.  They pointed out that as of last Tuesday, almost 80% of the shorts established in the first quarter had been covered.

They called last week the biggest week of short covering since they started following the data!

That number has surely only gotten higher as we have continued to grind up since then.

The moves we have seen in the most shorted names have been remarkable.  Stocks up 50% or more in the matter of a couple of weeks.

It is hard to ignore that this is the hallmark of a bear market rally.  They don’t call it a ‘rip-your-face-off’ rally for nothing.
 

COMMODITY STOCKS –
RISKS TO THE LEFT, RISKS TO THE RIGHT

 
Two weeks ago, I told my subscribers I was selling all my oil stocks. The reason? I just didn’t see enough upside left.

“I sold all my oils this morning.  Everything.  All of it… I’m not worried about missing A Big Trade in oil now. “

That turned out to be a good call.  It has been a rollercoaster ride for oil since then.  All commodities rocket up and down on each new promise of or failure to resolve the war.

But if you zoom out a bit further, oil stocks, all commodity stocks, aren’t doing much of anything.
There are good reasons.  Commodity stocks have multiple headwinds.

First, there is the news cycle.  Every indication of some sort of deal means that oil, coal, steel, grains – they all take a hit.

Anyone that has bid up these stocks over the past month has now been thrice burned by the news flow.  Investors are getting more reluctant to hit the ask going forward.

While no one really knows what is in Putin’s mind, what does seem clear is that Russia is not winning this war.  Putin’s only out – to save-face – is through a negotiated settlement.

That will be great for the world – but it would be less great for commodities.

The other headwind to commodities is the economy.

If and when an agreement is signed – what then?

A lot of evidence is pointing to a weakening economy.

A classic sign of a coming recession, the inversion of the yield curve, is already on us.

Source: Bloomberg

Consumer confidence is plunging and at levels typical of recessions.


 

Source: Federal Reserve

The consensus for first quarter Real GDP estimates has decline from 3.7% in late December to 1.7% now.   

The more-accurate Atlanta Fed data driven model (GDPNow) predicts only 0.9% GDP.   We are getting REAL close to negative numbers.

Source: Bank of America Capital Markets

Maybe most concerning – retail sales is starting to teeter.  Headline retail sales were flat in February (meaning Real or inflation adjusted retail sales fell).

Source: U.S Census Bureau

Restoration Hardware (RH – NYSE) shocked the market this week with the dour outlook CEO Gary Friedman gave on their quarterly call.

Friedman said that RH had seen demand soften in Q1.  But he was even more uncertain going forward – in fact he said he has never been more uncertain about the outlook in his 22 years in the business.

I don’t think anybody really understands what’s coming from an inflation point of view, because either businesses are going to make a lot less money or they’re going to raise their prices. And I don’t think anybody really understands how high prices are going to go everywhere.

Central banks are marching ahead and tightening right into this.

Bank of America is still saying the Fed is behind the curve.  They believe that we will see faster rate hikes and a “higher terminal rate”.  They see 50bp rate hikes in both June and July with 25bp hikes each of the other meetings.

The result – a Fed funds rate over 3% by May of next year.
 

NOT A BEAR MARKET RALLY – A WAR RALLY

 
Yeah, I know, the market is brushing this off like it does not matter.

It could be that the market is telling us we worry too much.  That the economy will be fine.  Don’t ever underestimate Mr. Market!

But it might not be saying that at all.  What if this is a war rally–not be confused for a bear market rally or cyclical upturn.

A war rally doesn’t care about rate-tightening or 3rd quarter GDP.  It is looking for stocks that outperform, for momentum, for exuberance!  We’re winning!

It is massacring complacent shorts in the process.

To be blunt, while war is not really “good” for anyone, it is not necessarily bad for stocks.  There are plenty of examples of a flat or up market during war-time periods, particularly if things on the front lines are going well.

Yet I’m being extremely careful here.  At some point this war rally will have run its course.  When it does, I think it’s quite possible that the market gives its head a shake and remembers what it was before the war.

I don’t want to be all-in when that happens. So I continue to sit on a huge cash pile.  My only real purchase of size was a tiny but fast growing fertilizer producer just hitting positive EBITDA.  I think it has a chance of being my biggest winner of 2022.

The move down in January and February was not about the fear of invasion.  It was about pricey equities, unprofitable equities, running into a freight train of rising rates.

It was about a slowing economy at a time of rising inflation.

It was about COVID still rearing its head and throwing a wrench in the supply chains again and again.
All those worries?  Still here. Worse now.

Right now, the market doesn’t care.  The post-war victory run is in full force.

But that will end.  All things do.  Reality will set back in.

When it does, I’m not so sure it won’t come crashing down on us.

EDITORS NOTE: To get Keith’s fast growing fertilizer stock CLICK HERE