Big week ahead
Anticipating FOMC and more earnings coming up
Quick summary:
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Last week was a miss in terms of predictions, with a limited loss (-1.4%) for the portfolio. Everything except the Dow reversed mid-week and pushed back against our predictions.
This week’s FOMC event should result in an expected (and priced in?) 25bps rate hike. How to position for this?
In addition to FOMC (and other central bank meetings), PCE inflation is reported on Friday, and a host of companies present their Q2 earnings throughout the week (including MSFT, GOOGL today and META tomorrow after close)
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The competition on the Q3 leaderboard is getting tougher. Some of those SPX and DJI predictions are quite impressive. Three weeks in a row keeping the score for each lower than 1 - nice! Keep it up.
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ORCA podcasts
A quick reminder that we started the podcasts via our YouTube channel. A new episode is coming up after FOMC this week. We will integrate them within the newsletter, so they will have their own section you are welcomed to follow.
For those who missed it last week, below is the video. It’s still relevant as an overview of the strategic macro situation, and tactical positioning amidst Q2 earnings reports:
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Anticipating FOMC
On Wednesday at 2 pm we get another Powell press conference where the Fed is expected to raise rates by 25 bps. This has been completely priced in, according to CME’s FedWatch probabilities:
Hardly any uncertainty left there.
The question remains, however, how to position for this? As you probably know, we do not place any trades before or during Powell’s speech (starts at 2:30 pm ET). We wait until the half hour has passed and then observe market reactions for the proper timing of our weekly entry. However, more important for us is to correctly position by the end of Wednesday for the reaction on Thursday.
Let’s discuss the probabilities.
First, the extremes at the tails. In the event of a 0bps increase (2% chance a week ago, 0% now), we can expect, with a high degree of certainty, a stellar rally throughout markets. Same if the Fed unexpectedly cuts. But, once again, this won’t happen. Almost no chance for these scenarios. Same for the 50 bps scenario (1.1% chance today). Highly unlikely, but if it does happen, expect a sharp sell-off.
Now for the 98.9% probability scenario: a 25bps hike. Even though it’s priced in, there is still a question of how markets might react. Five possibilities on the day:
(1) Knee-jerk up move - Initial reaction was due to the move being as expected, plus there is vol suppression as the event unfolded, so markets have to move up. Then there is a possibility of a slight push back during Powell’s speech, but this is quickly reversed when a dovish message is perceived and the market keeps going up. Over 90% of the time over the past 2 years, when this happened on the final trading hour on Wednesday, markets kept going up on Thursday as well. Last time this happened was February 1st.
(2) Down initially, then up - Initial reaction was down, despite an expected hike. In that case Powell’s speech, if dovish, can re-ignite markets back up. This is what happened in June. The next day, markets also rally.
(3) Sideways, but ending up down for the day. Several combinations possible here.
(a) An initial up move followed by a reversal during or after the speech (this is what happened last time in May, but also in March), (b) a down move, followed by a reversal, and then again down, or (c) a proper sideways trend that ends negative (last time in December). Either way, in >90% of such scenarios the market either opens negative on Thursday, or ends the day with a new weekly low.
To sum up, in cases (1) and (2), expect a rally continuation on Thursday as well. But if there is a sideways trend that closes down for the day, the probability that Thursday opens gap down (or ends negative) is very high.
The highest probability this time is for either of the first two scenarios, simply because investors already priced in rate hikes, and we had a few sell-offs to accommodate this.
HOWEVER - and it’s a big however - this time the FOMC coincides with earnings, so a few caveats are in order. A super busy earnings week is ahead:
MSFT and GOOGL will both come along after Tuesday’s close, which will open Wednesday either gap up or gap down. Price action afterwards is likely to continue sideways before FOMC. Then, just after FOMC, which will move markets on its own, we get META earnings, which proved many times to be a catalyst for a rally or sell-off.
A negative close for the day on Wednesday, after Powell’s speech, could reverse by Thursday if META spectacularly beats earnings. And vice versa, obviously; a sharp sell-off can happen if META fails to beat earnings and Powell happens to be particularly hawkish.
Predicting exactly what will happen is futile. But being prepared for each scenario by assigning probabilities is the best way to position. If earnings of GOOGL and MSFT disappoint, then FOMC could add to the sell-off. If they beat estimates, and markets gap-up on Wednesday, it’s hard to see the FOMC reverse this, unless they turn really hawkish. And then there’s META - we still give an earnings beat a higher probability, but will be fully prepared if it disappoints and pulls the market down on Thursday again, like TSLA and NFLX did last week.
I’ll do a post-FOMC blog post on Thursday, examining what happened, and discussing further macro implications down the line.
Last week’s performance
It was a tough trading week for us. We entered soon after Wed open, following our prediction that markets will continue to go up, buying at the highs, unfortunately. Wednesday’s price action was range-bound, but then a severe drop happened on Thursday (especially for the NASDAQ, which went down 2.3% on the day). Friday opened gap up, but then continued range-bound once again, offering little opportunity to profit with our strategy.
Overall, we missed 5 out of 6 indicators, only getting the DJI correctly - the Dow was insensitive to the sell-off in tech stocks, led by TSLA who, despite beating estimates, went down over 6% on Thursday.
The precision was decent (especially for the DJI), but with a directional miss, it was difficult to sustain a profitable week.
The events of last week, with the TSLA and NFLX sell-offs on Thursday, suggest that investors should be careful coming into this earnings week. Misses from META, GOOGL, and/or MSFT could be a powerful catalyst on the way down. However, probability of this happening is still lower than the opposite, more bullish scenario. Be prepared.
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