Overview

Markets continued to take a beating this week as investors tried to price in even more hawkish Federal Reserve action. This week notched three straight weeks of decline for all major indices, certainly a terrible start for 2022. The S&P500 is off 8.8% from all-time high, and down 7.8% for 2022. The Dow Jones Industrial Average is off 7.4% from all-time high, and down 6.34% for 2022. The Nasdaq Composite is the worst one, off 15% from all-time high and down 13.04% for 2022, in "correction territory." 

Technically, the market looks very bad. Let's take a look at each index's chart below.     

The selling carnage we've seen lately can be largely contributed to the market pricing in a very hawkish Federal Reserve (raise interest rates and quantitative tightening). We've talked about how these can affect valuation. Looking at the CME Fed Watch Tool, the market is currently pricing in 4 x 0.25% interest rate hikes as the most likely outcome by the end of the year. What's more interesting is the pace of how these expectations have changed over the past month. Expectations for three hikes this year declined from 30.2% to 22.7% over the past month, while expectations for four hikes jumped from 20.5% to 32% and expectations for five hikes jumped from 8.2% a month ago to 24.3%. Our view is that the market always overshoot to either side, and this time the market is pricing in too many rate hikes. Fortunately, we will get an update next week at 2:00 PM EST Wednesday when the January FOMC meeting concludes with a press-release, and followed by Fed Chairman Jerome Powell hosts the FOMC press conference at 2:30 PM EST. 

Earnings

Within the portfolio, for this earnings season, we have received earnings from Wells Fargo (WFC) and Morgan Stanley (MS) and you can read the writeups by clicking on their names. In the two weeks that major banks have reported, WFC and MS are the stars with blow-out numbers. 

What To Expect Next Week

Fourth-quarter earnings will really ramp up next week. Within the portfolio, we will hear from Microsoft (MSFT) on Tuesday after the closing bell; from Boeing (BA) on Wednesday before the opening bell; Nucor (NUE) and Danaher (DHR) on Thursday before the opening bell; from Apple (AAPL) on Thursday after the closing bell; and from Chevron (CVX) on Friday before the opening bell. As a reminder, we will provide full analysis of every earnings report.

Portfolio Status/ Thoughts On The Market

Despite the market correcting nearly 10% for 2022, with our active management, our portfolio is still holding on a ~5% gain so far in 2022. While nearly all portfolio names are down for 2022, we were correct to have sold when they were higher and held a decent cash position (20%). Into the past few weeks, we've deployed much of that cash into many positions (5%). The buys turned out to be too early as we didn't foresee such overpricing to the downside by the market. 

However, we view that the market is at very oversold conditions and we will see some bounce soon, albeit will not be a straight bounce to near highs. It is important to understand the following characteristics of major corrections: i) in order to put in a bottom, there needs to be a tug of war; ii) the road to the upside is not one without spikes and thorns. The two characteristics are derived from psychology of buyers and sellers. There is always a reason behind a sell-off. When buyers pick at the bottom, unless the reason magically goes away immediately, buyers will always have doubt and turn into sellers on any move higher. The correction doesn't complete (move back to the highs) until the market perceives that the uncertainty has gone away. 

The chart above is how we perceive the market will behave until at least April 22 when we have heard from the Federal Reserve about their plan for monetary policy, as well as get more economic data to assess how change in monetary policy will affect the speed of the economy. Here's a key distinction though. We drew the chart as if we know where the market bottoms, but the fact is, we don't. 

Given the above two scenarios, what we have to do is position and manage our positions as if both will occur. What does that mean exactly? Well, it is not that new to our portfolio management strategy: don't be greedy and sell when we have gains, and be nimble so that we can always buy at lower levels. The main underlying difference here is that while in a bull market we can wait patiently for huge gains (>10%), in a correction and volatile market such as now, we need to be ready to book smaller gains. We also need to be even more nimble and buy at lower increments. Overall, trading frequency will have to increase, the portfolio will change more drastically: what we call to "battle" with our positions.

Because trades will happen more frequently, going forward, we will not be able to provide real-time alerts of when to buy or sell. It is often that we will post the following day, or by the end of the week. However, you can always see what our portfolio looks like with automatically-updated holding details (here). Below are trades that we made in the past week.