Last week, shortly after when we published our thoughts warning that investors need to be careful about being too bullish, market quickly gave up the gain and turned its head around due to hot inflation number, hawkish comments from the Fed and worsening Russia-Ukraine situation. However, today, we're coming out with a call that investors should be prepared to get long again.   

Here's what we wrote:

[...] at this price level (only a few percentage points off from all-time high), the risk-reward is not as good. In terms of upside risk, we think the only one that exists is inflation peaking. But there are many downside risks: inflation not peaking, Ukraine-Russia tension, China-Taiwan tension, unexpected Covid variants, economic recessions. If we were at the depth of a 15 - 25% sell-off, we'd be willing to take the risks because at that point, the risks have been priced in. However, at these higher levels, the risks come back into play. 

The market took a dive after hot inflation number (and subsequent worry that the Fed needs to be more hawkish - restrictive  on monetary policy) and news that a Russia - Ukraine war is imminent. On Thursday, the S&P closed down 0.45%, nose-dived 1.99% on Friday and continued to trade down 0.20% on Monday. Tactically, we see the market re-testing the lows made in January, implicating a 3 - 5% decline from current levels, but not much more. The reason is that we believe the worst of i) inflation - hawkish Fed and ii) Ukraine - Russia risks have been priced in.

On i), market is now pricing in a nearly 60% of a 0.50% interest hike (from 0%) when the Fed meets for the FOMC meeting in March (according to CME FedWatch Tool here). What's more interesting is how rapid and aggressive this expectation has moved up compared to a month ago, when market was at lower levels. Specifically, exactly a month ago, the probability of the March 0.50% rate hike was at 3.3%. What's practical is we don't believe this will happen because the majority of Fed officials don't support it (see last week's round-up here). Therefore, for this case, there is really no downside risk: the upside risk is that Fed will not do a 0.50% hike, but even if they do decide on a 0.50% hike, the market has already priced this in.

On ii), market is basically expecting a Russian invasion of Ukraine to happen at any moment now. You see headlines from all over the news about this conflict. The time to sell (to price in this risk) was last week, not now, and definitely not when it actually happens. Remember, market is a forward-looking mechanism, it tries to price in potential upcoming risks, most often times more aggressive than necessary. When the risk actually becomes a reality, often times market has already moved past it and tries to find the next catalyst for the upside, or the next risk. 

So what should you do? As you may know by now, we never try to call a bottom or call a top in a market. What we do is evaluate price levels and argue whether it makes sense to buy or sell. We are saying this level makes sense to buy (given the reasons stated above), but you should always be ready to buy more on the downside. 

If you are new to the market, deploy about 30% of your money today. Wait for the retest of January's low to happen and deploy another 20%. If you are a current investor and have raised cash into the sell-off like we did, you should be looking to reduce about half of that cash position (by buying beaten down stocks of strong companies), be ready to go to cash-neutral (no cash) at lower levels. 

The bottom line, we think it's time to get constructive on the market again.