On the Edge of Chaos: Regional-focused contrarian investors will outperform traditional macro strategies in 2023

Just as many investors were preparing to throw in the towel, so was the Federal Reserve signalling that it is about to halt its rate hikes. Meanwhile, the latest jobs report suggested wage growth is slowing. The combination of rising pessimism and a potential change in behavior by the Fed sparked a nice rally in equities and a deft reversal in the US 10-year Treasury yield ($TNX) on Friday.

However, if inflation shows signs of picking up steam when the latest CPI numbers are released, we can expect more hawkish talks from the Fed, a possible $TNX reversal and a fresh slide in equities.

Data point to a slowdown in the economy

Bond yields are a long way off their recent highs. That’s because there’s an increasing amount of private macro data, especially newer ones PMI and ISM Figures suggesting the US economy has been slowing for months and the slowdown may be accelerating.

There are also regional fluctuations in the economy (see below) that the central bank and most private analysts don’t comment on — the regional fluctuations could ratchet up the Fed while creating potential gain areas for investors who know what matters to look for.

From a trade perspective, the external macro backdrop, such as Fed actions and economic data, is important. But what’s happening in the stock market matters most. Therefore, as a contrarian investor, I propose the following two caveats for the year:

• Try to invest in run-down sectors where those who panic will fold; and
• Consider a regional bias in where you invest your money.

First, let’s look at some key economic data from a contrarian perspective.

ADP data

While the PMI and ISM data don’t break the data down by region, it is the most recent ADP Private Employment Report does. Certainly, the headline saying that the private sector created 235k was a market mover as investors took it as bad news that would push the Federal Reserve to continue its rate path “higher for longer”. Still, the figure was close to government data released a few days later.

A closer look at the data (see page 2 of the ADP report) clarifies my point, as private job growth was in the Northeast (54,000 new jobs), Midwest (70,000 jobs), and South (253,000 jobs). Meanwhile, the West lost 142,000 jobs.

U-Haul Data

Comparing the ADP data to U-Haul’s 2022 one-way target data shows a notable correlation as Texas, Florida and the Carolinas were the leading regions. In addition, California, Illinois and New York were leaders in one-way flights.

Further analysis of the ADP data shows that the New England region (roughly including New York) added only 2,000 new jobs, while the West North Central region (including Illinois) added 9,000 new jobs.

More interestingly, the highest job counts in the ADP among the goods manufacturing sectors were 41,000 construction jobs. ADP didn’t list where the construction jobs were added, but it wouldn’t be surprising if most of them were in the South.

split decision

The Fed looks at data for the entire US and also includes global data. The problem with this approach is that there are large regional differences in economic activity in the US. This data is no longer anecdotal. Recently private sector reports, as well US census data, confirm what the U-Haul and ADP data say, namely that people are leaving certain regions of the US and permanently moving to others.

In other words, the current data that the Fed relies on — GDP and other national stats — may not show an actual recession, as economic activity in the Sun Belt may be growing at a decent pace, while New York, Illinois and the West Coast might Having trouble. This creates a potentially chaotic situation for the Fed as it ponders what to do with future rate hikes. When the recession hits, it will likely hit areas where people are migrating harder than areas where people are migrating.

Think regionally

Because the Fed is one-size-fits-all and local realities can vary significantly depending on regional realities, investors who think regionally are more likely to do well in 2023 than those who follow the widespread national macro at Wall Street and the Fed . In other words, those sectors that benefit from the migration and resulting outcomes are most likely to deliver the best results as long as the Fed remains in its ‘higher and longer’ mode.

Here is an example. As people move to new areas of the country, infrastructure will be needed as roads will need to be repaired and upgraded, utilities will need to expand their grid, and energy needs in those areas will increase. Above all, jobs must be created to support population growth.

Building materials have been a neglected area of ​​the stock market for decades. Yes, cement, concrete, lumber, insulation, glass and the machinery to use them will be central to moving forward for areas of the US faced with housing a growing population. And a one-stop shop to consider might be exchange-traded fund Materials Select Sector SPDR (XLB).

As you can see in the chart above, XLB has been a source of relative strength as can be seen from the Relative Strength Index (RSI) lately. It has had a nice rally since its last bottom in October 2022. Accumulation/Distribution (ADI) has been very stable, meaning short sellers are finding other places to list their wares. Meanwhile, Total Volume (OBV) has bottomed out, which means the sellers are pretty much done as well. This creates a potentially bullish scenario for this sector ETF, especially if it can break above the 200-day moving average (MA) and the major one volume by price cash (VBP) around $82.

The bottom line is that even if the Fed continues to hike rates, there are opportunities in this market. Investors just need to dig deeper and consider the macro effects of what’s happening on the ground.

Welcome to the Edge of Chaos:

“The Edge of Chaos is a transitional space between order and disorder that is believed to exist in a variety of systems. This transition zone is a region of limited instability that creates a constant dynamic interplay between order and disorder.“—Complexity Labs

NYAD questions 200-day moving average

The New York Stock Exchange (NYAD) Advance Decline Line surpassed its 50-day MA on January 6, 2023 and is about to challenge its 200-day MA. A sustained move above the 200-day ma would be a very bullish development. Note that all countertrend rallies in this bear market have failed at the 200-day ma.

For its part, the Cboe Volatility Index ($VIX) continues to roll. That too is bullish. When the $VIX rises, stocks tend to fall as rising put volume is a sign that market makers are selling stock index futures to hedge their put sales to the public. A drop in the $VIX is bullish as it means fewer put option purchases.

Liquidity has remained surprisingly stable as the Eurodollar Index ($XED) has trended sideways to slightly higher over the past few weeks.

But the current situation is a little different. You can see that stocks of DR Horton (DHI) and Lennar (LEN) fell for several months in 2022 as $TNX rose. However, stocks responded well as yields reversed. You can see that real estate company Redfin (RDFN) stock price has yet to recover.

The S&P 500 Index ($SPX) found support at 3800 and is now testing its 20-, 50- and 200-day MAs. Accumulation/Distribution (ADI) has stabilized, but OBV remains near its recent lows. ADI indicates short sellers are making quick profits and exiting, while OBV suggests sellers aren’t quite done yet.

The Nasdaq 100 Index ($NDX) continues to lag the $SPX sharply. It is still possible that it has formed a triple bottom with the 10,500-10,700 price area providing short coverage. The problem is that the 12,000 area and the 200-day ma together form a sizeable resistance band.

For the most up-to-date information on options trading, visit here Options trading for dummies, now in its 4th edition – Get your copy now! Now also available as an Audible audiobook!

#1 New Release in Options Trading!

Good news! I created my NYAD complexity chaos diagram (on my YD5 Videos) and a few other favorites public. You can find them here.

Joe Duarte

In the money options

Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is the author of eight investment books, including the bestseller Trading options for dummiesrated a TOP option book for 2018 from Benzinga.com and now in its third edition, plus The book “Invest everything in the 20s and 30s”. and six other trading books.

The book “Invest everything in the 20s and 30s”. is available at Amazon and Barnes and Noble. It was also recommended as Washington Post Color of Money Book of the Month.

For Joe’s exclusive stock, option and ETF recommendations, visit your mailbox each week https://joeduarteinthemoneyoptions.com/secure/order_email.asp.