Cleaner Not Clean

Between the Lines - Vol. 16

Good morning,

With the S&P trading at 7,800, it has managed to make me look right and wrong at the same time.

Some time ago, I said that SPX could trade to 8,000 this summer. I also said that the destination was considerably easier to forecast than the path, and that a 5-10% air pocket could arrive before or after it. Just before the market sold off to the low 7300s, I chose the bearish path and made 7,200 my base case before 8,000.

The market has rallied just shy of 500 points since Wednesday’s low and is now 200 handles from the 8K handle. I am not going to hide from the fact that I gave too much weight to the downside during the dip. But equally, I am not going to pretend that the original 8,000 forecast no longer counts merely because I bought protection against the journey. Unfortunately, the market chose the road I assigned less probability to. I got bullish on the 30th March this year, after a small technical indicator flashed bright and have remained bullish ever since… At some point I was bound to misread one bend in the road.

The more important point is that I did not turn uncertainty over how we got to 8k into a huge short position. I remained long throughout the sell-off and the entire rally. I cut AMZN after earnings for a gain, which I explain later in the post, but have kept my Phase3 basket at a 20% weight, ORCL at 10%, META at 9% and MSFT at 7%. The puts have been a small PnL drag as the market reversed, but my book has continued participating; if anything, it’s outperformed.

In my last post I wrote:

“If SPX goes straight to 8,000 as previously forecasted, the hedge costs me 1%, and the rest of the book should make money. Fine.”

The part I got wrong was how much work the first puke had already done. I focused on the fact that longer-term leverage and momentum exposure remained elevated and concluded that the initial sell-off still had considerably more work to do. The positioning reset had already become enormous. One prime book recorded the second largest de-grossing in its available decade of data. Fundamental managers had taken gross towards one-year lows, and some momentum factors were down 40-50% from the highs.