May 2022

Trading Update (Jan – May 2022)

Since my last trading update post, I have decided to stop posting detailed trades. Instead, I will post more generic trading updates. The reason is that getting, prepping and posting the detailed trading info is too tedious, and I am not able to concentrate on my trading. Hopefully the generic trading updates will be more useful to you.

At the start of this year, I was not expecting to trade a lot. My position sizes were small, and markets were uncertain. However, after a slow start, I realized that I was still somewhat able to read the markets I trade in. Thus I increased my position sizing.

I was on a pretty good run until the last few weeks. The recent losses cut my profits for the year by about half. Market conditions have changed, and it means that I need to tweak the trading strategy that had worked well for me this year until recently.

State of the Markets (23 May 2022)

Since my last market state update on 13 May, markets have fallen slightly. S&P is now at 3901 vs 3930. There was a bounce, but it was not sustained, and markets fell back.

Drivers of Market Sentiment

How have the main drivers of market sentiment changed? 2 of the main drivers are stated below:

Inflation
- still remains a strong market-driving force
- inflation-related economic indicators have remained high
- Feds remain firm on rate-increase stance
- War goes on, maintaining upward pressure on selected commodities
China slowdown
- sentiment improved
- economic data remains poor
- but re-opening and policy action has given more hope for the future
- china-related stocks and commodities have relatively outperformed

Overall market sentiment remains negative, though there is some improvement thanks to China news flow.

Trading Outlook

Markets are now low enough for some bulls to view as a buying opportunity, especially when coupled with the improvement in Chinese sentiment. However, inflation-related forces remain a strong downdraft. The likelihood of further market retracements is probably still higher than that for sustained rebounds, though the probabilities are more balanced now.

For me, I find it harder to short the markets. The probability of sudden unexplained rebounds has increased. Trading indices are trickier, due to the more balanced upward/downward forces.

In the commodity space, China re-opening, policy easing and the ongoing Ukraine invasion are supporting prices in spite of current weak data points. Furthermore, commodities are seen as good to hold in times of high inflation. Given the abovementioned support for commodity prices, it will probably be difficult to execute commodity and commodity-related equity shorts.

Investing Outlook

The probability of a successful equity investment has actually increased as prices have fallen. However, the central bank tightening impulse is just starting, so there may be even better opportunities awaiting in the equity space. “Expert” sentiment is starting to deteriorate, with more negative opinion pieces and forecasts coming everyday.

I have no equities at the moment, so I will probably wait for lower prices before starting to buy. There is still a good probability of prices going lower. Central bank tightening has only just started, so it is going to remain a significant downward force for some time.

Bonds are still unfavored due to the increasing interest rates. But sentiment may reverse if inflation expectations come down and/or global economic growth starts to slow down more than anticipated. It is somewhat still a contrarian play to increase exposure in bonds.

However, I still feel that bonds have a relevant role to play in an investment portfolio. Thus I actually have increased bond exposure gradually over the last few months, and fortunately they have been holding up. There are many different types of bonds, we need to be selective and choose the appropriate types for the current financial climate.

State of the Markets

Markets have dropped a lot in recent days. S&P 500 settled at 3930 yesterday (12 May), down a whopping 700 points from 29 March (4631) and more than 800 points from its all-time high of 4818. It is very close to entering a bear market (20% drop from the peak).

Is it time for a decent bounce? Probably, but news flow has been poor, very little fundamental change has occurred. This means that if there are no major news flow surprises, any bounce may be relatively small and short-lived. In such cases, agility is required to move in and out quickly.

If any positive headlines appear, there should be a stronger bounce. It is also entirely possible for the markets to just slowly drift downwards or sideways. It is a tricky situation to trade indices or stocks with high correlation to the general markets. None of the possible scenarios have an significantly stronger probability of occurring than the others. Hence there is no high-conviction outcome to bet on.

If you trade in any niche markets/stocks which are relatively disconnected from the general markets, this should not affect you so much. If you still would like to trade, please monitor news flow closely and get out quickly if any headlines pop out which are negative for your trade(s).

Maximizing Certainty In Times Of Great Uncertainty

Volatility is back in a big way. Dow Jones has had a couple of 4-digit swings, and it has been a bloodbath in many markets. Uncertainty in overlapping major risk areas is fueling a brutal sell-down.

The risk areas include:

China slowdown due to COVID measures and property weakness
Central bank tightening due to persistent inflation
Commodity imbalances due to Russian invasion

In highly volatile situations, I find it useful to establish as much certainty as possible, because uncertainty fuels fear and leads to sub-optimum decisions being made. Reaffirming and reminding ourselves of the certainties make it easier for me to maintain rational decision-making.

Everyone has their own set of high-conviction ideas from which to establish these certainties. Some of my own are:

1. Considering the very long term picture, it is still possible for markets to fall significantly further

Looking at the big picture, recent falls do not actually look very big. Markets have risen a lot, and recent falls are much less than recent rises. It is entirely possible for the S&P 500 to fall significantly below 4000.

2. No one can predict the markets with absolute certainty

Trust no one. Many will seem to know a lot and present compelling evidence, but it is impossible to be absolutely sure about the markets. Trust no one entirely.

3. Avoid crowded trades even if they seem logical and well-recommended

When a trade has become crowded, potential upside becomes limited and potential downside conversely grows a lot.

4. What goes up a lot has a higher probability of falling a lot

No matter how compelling a high-flying stock’s business case, it always has a higher chance of falling fast to the ground. Remember that fundamentals can change, and research reports are not perfect.

Conclusion

Reinforcing your own set of certainties will help anchor yourself in volatile times, and prevent decisions being made based on more emotion than logic. To develop your own set of high-conviction ideas, do read extensively and spend time to analyze markets deeply.

Month: May 2022