Stagflation leading to Recession - The Kodiak Bear Thesis

[TheHouse]

I want to share my trading strategy and circle back around to an opinion I shared in Aug about a smaller CPI print and how the market would most likely react. In that same post below I also shared some thoughts on how a recession has more to do with consumers financial health, credit impulse, and company evaluations vs “peak inflation”.

The Think Tank: Macro Discussion and Opportunities Brainstorming

I really love this thread and I think it could be insanely valuable to Valhalla. We have the ability to get ahead of data and anticipate where equities will go and what the economy will do in a very intentional and systematic way. I want to talk about the fed a bit then talk about how I discern data points from the perspective of the real economy and or sentiment, but first, Something I have been wanting to say about macro trading: IMO Valhalla wins when we try to understand what is actually happening in the market instead of reacting to the market. The best trading days I have had this year were broad market declines based on Macro, literally anyone could have bought puts in almost anything and made money. No callout necessary. Look at the Beakmap from last Friday or today for instance, you could have throw a dart at it and wherever it landed would have made money scalping puts with the conviction and understanding of the move. Although targeting specific names has value, outside of ER’s trading macro has less to do with the individual names declining on a single day as it has to do with why they are declining in the first place. Then from that, you find the easy targets, usually starting with a sector first. Hopefully we can all learn from each other here and get a little better at understanding this wild market every day. This is why I love Valhalla and why I am here. The fed is pulling what levers they can to fight inflation without cratering the market. They have 2 mandates, one is stepping up in times of crisis and the other is to manage inflation. We are seeing #2 now, will most likely see the other within the next 12 months. If we think about this from 2 camps it looks like this. #1 The fed is hawkish and tightens to control inflation. Great, we wont have roaring inflation like we saw in the 70’s. But as destructive as high inflation can be to the economy, tighter monetary policy or deflation is equally as destructive to balance sheets thus equity markets due to less cocaine in the system (credit) Less credit or leverage means less buying power or demand to go around. #2 The fed doesn’t do enough to get a hold of inflation. This means most American’s continue to be squeezed by high prices in areas they need, like housing, food, and energy. Excess dollars or discretionary income get funneled to select sectors while the rest of the market suffers. In both cases, any purchases that were made during the cocaine frenzy need to be paid back. This could be homes, cars, credit cards, business loans, in store revolving accounts, etc. Regardless of what the fed does now there is pain ahead in the form of a recession, this pain most likely will be longer and harder than most expect. Again, where is the bull case here? Where is the demand going to come from? From my research into every bear market, recession, and black swan event from the last century and further, I believe we are headed into a global contraction that will last 12-36 months …

My opinion hasn’t changed and think we may be currently sitting in that dislocation. The issue with the hyper fixation on the fed is that they serve a large part of the economic equation but not necessarily from the ways you may expect.

IMO the fed is not the main character of this story. They do play a significant role in bringing down inflation and inflation does help then hurt the economy but elevated inflation alone is not responsible for the all of the economic challenges we face. Take a look at inflation in the last 2 recessions.

Peak inflation Dot Com recession
Mar 2000 @ 3.8%,
Official start of the recession Mar 2001
CPI @ 2.9%
Offical end of the recession Nov 2001
CPI @ 1.9%

Peak inflation GFC recession
July 2008 @ 5.6%
Official start of recession Dec 2007 (Announced Dec 2008)
CPI @ 4.1%
Official end of recession
CPI @ -1.4%

In both examples inflation was at play but not the main driver of the economic contractions. Inflation in both cases peaked and a recession followed. Just like every recession in the last 100 years. 2022 isnt any different in real economy as far as headwinds go, Id actually argue they are worse but inflation this go around is and has been a bigger problem.

We dont know how sticky inflation will be or if we have actually seen it peak. IMO it probably has, but that obviously doesnt make me long term bullish for the broader market in the slightest. Outside of select sectors ill be thinking about going long when 3 things happen.

#1- Fed Pivot (not this smaller hike/pause bullshit) a real pivot meaning cutting rates.

#2- Earnings - Ill only be going long in companies that are trending in the right direction fundamentally. Cant have one without the other.

#3- Economic indicators move bullish.

Until then, the strategy I posted in TF is designed to move with the market. Taking advantage of big moves. SPY, QQQ, HYG, GOLD, & SLB are my main tickers and I chart them daily. Im always in both directions meaning Im always hedged. As the market moves I move positions around (ideally this means taking profits) based on trend, individual movements, and my key indicators. Yields, DXY, VIX, HYG, & AAPL.

Yields- Short term I look at how they are moving then look at the relationship between different maturities, mainly front end vs back end.

DXY- Dollar (Big +/- moves in QQQ, GOLD, SLB)
(Play directly in UUP for short scalps)

VIX- (Use this as a temperature gauge)
(Play directly in options or UVXY)

HYG- Highly correlated with SPY, creates divergences intrayday that are my highest win rate trades. Also a good temperature guage for the real economy.

AAPL- High weight in SPY/QQQ, also a great temperature gauge on broad market movement and risk on/off sentiment.

While watching data, earnings, news, etc. I then I look at technicals, mainly fib lines, MACD, RSI, and volume.
Risk management/Capital Preservation is guided by hedging, position sizes, dte, and strike.
If we get a strong trend Ill scalp select names or indexes when I can.

Its not perfect and requires a decent amount of management but it has been working for me for the last few months so I suppose Ill continue to play it until it doesn’t.

Hope this is helpful, good luck and stay cautious out there friends.