Market FIRE Commentary: Nov. 2022

Predicted October 2022 Technical Rally Had Materialized and Now Has Faded, as Bear Market Continues to Take Hold

As I write this commentary on 11/3/2022, the post-COVID Bear Market has reasserted its grip following the predicted October over-sold technical bounce in the stock market. The October rally occurred with no new good news to indicate any significant lessening of inflation (CPI, PPI, or PCE) and with some news of economic contraction (in reduced manufacturing activity and slightly higher jobless claims), suggesting that a 1970’s-style period of “Stagflation” is a conceivable scenario that may yet unfold. The October rally also occurred as 3rd quarter company earnings reports have been largely underwhelming compared to most prior quarters, especially in the technology sector (including previously better-performing profitable big tech companies such as Microsoft, Alphabet, and Amazon). Now, with the start of November, the market is digesting the Federal Reserve’s latest 0.75% interest rate hike and Chairman Powell’s hawkish remarks to the press, in which he said that interest rates would be going higher than previously contemplated before any consideration of a “pause” would be appropriate. The market appears therefore to have resumed its downward trend.

Year-End Rally Expected Based on Forecasted Republican Sweep of Mid-Term Elections and Lower Pace of Continuing Rate Increases

Although more economic pain is likely ahead, investors and traders still should consider positioning themselves for an end-of-year rally, for two main reasons: (1) an increasingly likely Republican wave in next week’s mid-term elections, and (2) the Federal Reserve’s likely slightly reduced pace of interest rate increase at the final rate-setting meeting for the year in December. Both of these two forecasted happenings (certainly far from inevitable at this stage) would be presumed to spark more positive market sentiment and a considerable rally through the end of the year.

Regarding the mid-term elections, it is this author’s projection that the Republicans will win a majority in not only the House of Representatives, as has long been expected, but also the Senate, which had been believed to be a closer contest. Late-breaking economic- and crime-driven momentum — along with candidate-driven success at framing the narrative — suggest GOP retentions in Senate races in North Carolina, Wisconsin, and Pennsylvania, and GOP pick-ups in Senate races in Nevada, Georgia, and Arizona, and conceivably also in New Hampshire, Washington, and Colorado. The Georgia race may not be decided until December if neither major-party candidate gets the required 50% in that state, which would cause the race to go to a run-off election; however, majority control of the Senate may well be decided by the results in all other states by the end of next week, after substantially all vote counting has been completed.

Republican control of Congress would trigger the financial market’s general favorable view of divided partisan control of the federal government, based on the tendency of such a configuration to block overreaching legislative initiatives. Additionally, and more specifically related to the present economic problems, Republican control of Congress would project an expectation that federal spending will be much more restrained over the next two years, with fewer (if any) new trillion-dollar spending sprees of the sort that have fueled inflation over the past two years (and longer, even before the Biden Administration and during the earlier days of the COVID pandemic). A shift in the present inflationary fiscal policy stance should complement the Federal Reserve’s recent contractionary monetary policy, thereby increasing the chances that inflation will be mitigated in 2023 and that interest rates may thereafter be reduced or at least not increased much further, which should be favorable for the stock market.

The second projected year-end condition that should lead to a year-end rally concerns the highly plausible scenario in which the Federal Reserve ever-so-slightly reduces the rate of additional interest rate increases, starting with the Federal Reserve’s December 2022 meeting. Although muddled by Chairman Powell’s post-November meeting press conference, the Federal Reserve’s written 11/2/2022 statement indicated that the Fed would consider the effect of future rate increases on the economy as it relates to the extent of further increases. This pragmatic forecasted policy is also consistent with the fact that the Fed has already increased interest rates to such a great extent so that rates are approaching their projected near-future maximum restrictive levels. Reporting by well-connected journalists at the Wall Street Journal on Federal Reserve Board member thought processes seems to be telegraphing this policy shift. If for instance a 0.50% Federal Funds interest rate increase occurs in December instead of 0.75%, then it is believed that the stock market would react very favorably in the short term through the end of the year, especially with the technology stocks that have been hardest hit in the current bear market and that are most at risk when interest rates are rising.

Intermediate-Term Outlook Remains Cloudy But Overall Bearish

The path of the stock market for 2023 remains muddled and depends largely on whether inflation will soon be contained without a severe recession occurring. The first one or two quarters of 2023 are likely to involve a continuation of the current bear market rather than the start of a new bull market, but new inflation data could well change this intermediate-term outlook.

Market FIRE Investors Should Consider Strategically Positioning Portfolios for Year-End Gyrations Based on Federal Reserve Actions and Mid-Term Elections

In the shorter-term, it is forecast that the market will continue its post-Fed meeting downturn into next week. By the middle of next week when the outcome of the mid-term elections should be clear, that outcome should be a powerful catalyst through the end of the year for another upward turn for the stock market. End-of-year tax-loss harvesting may will mitigate this rally in early December, given the steep losses that most investors have this year, but the usual “Santa Clause Rally” should take hold during the last part of December.

Given the above forecast, Market FIRE investors should consider buying-to-close profitable covered call options by Monday and Tuesday of next week — the week of 11/7/2022. They should consider carefully buying-to-close even unprofitable and/or deep in-the-money covered call options during this timeframe in order to ultimately obtain a more balanced strike price on new covered call options.

Market FIRE Investors should further consider delaying selling covered call options on available long stock positions until their underlying RSI levels reach 50 or higher during the one- to two-week periods following the mid-term elections. Strong consideration should be given to writing new out-of-the-money covered call options on available long stock positions with strike prices that are well above the then-current market price for the underlying stocks, given the likelihood of higher options premiums during any upswing and the interest of avoiding assignment under the options for the underlying stock should prices greatly appreciate during this time period.

Additionally, available capital may be deployed towards beaten-down stocks in profitable technology companies with strong long-term prospects and favorable shorter-term prospects in any scenario where interest rates may be nearing peak levels.

Variables that may undermine this commentary include a deterioration in Ukraine’s position in the war with Russia, an escalation in tension with China, other new geopolitical tensions, a failure to achieve any progress in inflation reduction, evidence of an impending steep recession (as opposed to moderate contraction), and any outcome of the mid-term elections that results in continued unified control of Congress by the Democrats. This is not individualized investing advice and is offered for informational and educational purposes only. Investors should conduct their own research and seek individualized advice from registered investment advisors before acting on any investment recommendations or commentary.

Stay tuned, stay invested, but also stay appropriately hedged!