ALERT: Putting on Short Term Hedge on QQQ--My Sleep Well At Night Insurance Strategy
Hey Subscriber,
With interest rates dropping 20% in last few days, traders and investors clearly confused as to which economic scenario they are playing.
Going to put on a hedge via the SQQQ to sleep well at night with bond market acting very strange.
Buy to Open 25 SQQQ Calls July 23 Limit 0.20
The short term scenario
Analysts struggling to explain the falling yields, pointing to concerns about the Delta variant of COVID-19 and the Fed's increasingly hawkish outlook as potential contributing factors.
One feet-on-the-ground realist economist I follow in a group I belong to and respect highly is Sonal Desai who runs $1.4 trillion in fixed income at Franklin Templeton. Sonal, who has a Ph.D. in economics from Northwestern University, leads Franklin Templeton's fixed income investing team since 2018. The firm is the world's 16th-largest by assets under management (AUM), holding $1.4 trillion as of July 2020. She explains the conundrum for big money managers right new
"I don't have a crystal ball, but I would not bet on the dream constellation of strong policy-supported economic growth, low and stable inflation, loose monetary policy, and ever-rising asset prices that markets seem to hope for."
She added, "Something has to give."
I agree--there will be days that the market is just too confused on which economic scenario plays out--and runs for cover aka buys 2-5-10 year bonds and waits on their hands.
Desai discussed how the fall in bond yields could help analysts predict market movements over the next six months, and shared three possible scenarios.
"Regardless of which scenario plays out, something in the current constellation of asset prices doesn't add up," she said. "Over the next six months, most likely, we will find out what does."
First, Desai speculated about a return to "secular stagnation". In this scenario, the fall in yields points to a future where growth fizzles out, perhaps due to a lack of fiscal stimulus or further restrictions to curb the spread of the Delta variant.
"After a strong, brief rebound in growth and a sharp short-lived jump in inflation, we quickly get back to a long run of slow growth, low inflation, and low-interest rates," Desai said. "This, by the way, is the view implicit in the official growth forecasts of the US administration."
In this potential scenario, stock markets would experience a dip, with lower earnings leading to repricing (except for our Global Digital Platform Dominators IMHO) .
Desai's second prediction is far more optimistic: She imagines "a productivity renaissance." In this timeline, concerns over the Delta variant subside and American politicians reach a consensus on government spending.
Workers would return to the labor force, companies would spend more on research and innovation, and the stock market would boom.
"Markets will have to start pricing in higher rates. Stock markets will be supported by the tailwind of productivity on earnings, corporate bonds will benefit from a healthier profitability outlook, but long-duration 'safe-haven' assets will look markedly less attractive," Desai said.
WE ARE IN this camp--with a few bumps and nasty days and normal 5%+ corrections ahead of course.
Lastly, Desai said she feared that the economy could be set to experience "classic overheating". She said that most economic data currently points towards this being the most likely of her three scenarios.
"In this classic overheating scenario, loose monetary and fiscal policies feed sustained inflation. Not necessarily a return to the 1970s, but a persistent 3% to 5%," Desai said. During that decade, oil supply shocks jolted inflation and the Fed raised interest rates to 20% in response.
In such a situation today, stocks would enjoy an initial boom before becoming more volatile as the Fed introduces measures to curb inflation.
"Market rates will move up faster than the Fed, punishing duration exposure in fixed income," Desai said. "Stock markets should be initially well supported, but then increasingly nervous as the Fed gets ready to tighten."
Desai's three differing predictions point to rising uncertainty in US stock markets ahead of the second half of 2021. The fall in bond yields will make investors even more nervous.
"The unusual degree of uncertainty in the current macro environment allows for a wide variety of views on how things will play out,"
"Place your bets, and get ready for more volatility," she added.
We have Sonal--but hedging bets with cheap SQQQ calls never hurts--the chart is bullish now--XOP put options next!
