2022 was a difficult year for most market participants. The main reason was the restrictive environment created by the Federal Reserve. They’ve been raising rates and taking liquidity out of the system in order to fight inflation. I anticipate better conditions later in 2023, but as I’ve consistently said over the past year, we will not see any sustained upside until the Fed stops or at least pauses their current rate-hiking cycle.
When can we expect this pause? My guess is March of 2023 for two reasons. The current Fed Funds rate is 4.25-4.5%. Their target rate is approximately 5.0-5.25%. That means we can expect 50 to 75 more basis points of rate hikes in 2023. These are likely to occur over their first two meetings (February 1 and March 22). By then, the Fed will have reached their terminal rate and they are likely to announce a pause to allow approximately 500 basis points of rate hikes in 14 months to be absorbed into the financial system.
The second reason is that the past three bear markets all bottomed in March. I realize it’s not a large sample size, but as you can see from the charts below, the 2000-2003, 2008-2009, and 2020 bear markets all began their new uptrends in March. This seasonality combined with the anticipated timing of a Fed pause makes sense for a potentially tradeable bottom in March.
(charts will be posted after the article is published)
What would lead to this bear market to last longer than March? Any uptick in future inflation data would keep the Fed hawkish in their tone and restrictive in their policy. In other words, market participants still have to remain patient until the technicals improve and we see signs of the big institutions consistently coming back into the market.
From now until the Fed verbally announces a pause in their rate hikes, I plan to remain defensive. It wouldn’t surprise me to see a 5-10% decline to start 2023 mainly because the major indexes are below their key moving averages and the market looks vulnerable. Besides higher inflation, any unexpected event could hurt an already fragile market. The accommodative conditions since the global financial crisis led many people to forgetting that discipline and patience are two big keys to surviving bear markets.
When the market eventually turns, there will be strong opportunities for those who like to trade individual stocks. For example, coming out of the 2009 bear market, Green Mountain Coffee and Netflix were two of the first stocks to move to new highs and went on to achieve tremendous gains. In other words, even in a difficult market environment, there are always companies that are in their early-stage growth periods. As soon as the tension is relieved off the market, these stocks are usually the ones to move to new highs and have a higher probability of success.
One sector that I will continue to focus on in 2023 is Biotech. Many stocks in this group are showing great relative strength and Big Pharma has tons of cash available for potential M&A. Another sector will likely be Semiconductors. During every bear market rally in 2022, this group advanced very well and still has many stocks with low valuations and great growth prospects.
To summarize, remain defensive and don’t fight the Fed until they pause their current rate-hiking cycle. Protect your capital and your confidence because once market conditions improve, there will be strong opportunities on the long side.
Unusual Option Activity
12/27/22 Axsome Therapeutics (AXSM) with 1000 Jan 13th $90 calls bought for $1.24
12/12/22 Axsome Therapeutics (AXSM) with 680 Jan. 2024 $30 deep ITM calls opening for $3.5M
12/30/22 Axsome Therapeutics (AXSM) buyer of 2000 January $80 calls for $4.10 offer
12/19/22 Amylyx Pharma (AMLX) 320 January 2024 $45 deep ITM puts are sold to open for $15.75, often bullish sign in biotech names
10/4/22 Amylyx Pharma (AMLX) more unusual bull put sales with 1000 January 2024 $35 sold to open for $12.40
10/3/22 Amylyx Pharma (AMLX) unusual opening seller 555 January 2024 $35 ITM puts for 12.80
10/3/22 Amylyx Pharma (AMLX) with 1600 January 2024 $30 puts sold to open at $10.50 to $10.30
12/21/22 Cincor Pharma (CINC) interesting flow today with 2500 August $15 short puts opening $4.70 to $4.80, a Biotech that was crushed late November as its experimental hypertension drug failed to meet the primary endpoint in a Phase 2 clinical trial. CINC now has a $480M market cap and trades less than cash value. Barclays started Overweight on 12/7 with a $22 target seeing a rare opportunity to own a blockbuster asset with a key readout due in 2H23. Jefferies also defending shares on 11/30 noting a strong balance sheet through 2025 and the company moving ahead with Phase 3 studies seeing value in the company’s blood pressure pill and has a $50 target. Piper lowered its target to $53 and sees recent confounding data to be controlled in Phase 3 and lead to a positive outcome.