🗞 The American Nightmare?

WHILE YOU POUR THE JOE… ☕️
Another One Bites the Dust

Shares of D.R. Horton dropped by over 13 points, or 7.2% 📉, after reporting worse-than-expected earnings. We saw this coming a mile away despite taking the wrong side of this trade before the close on Monday.

Being wrong on D.R. Horton didn't hurt. Why? Because our big short position is in Toll Brothers stock.

We posted our thesis a while ago, but if you’re new here, you can find it here.

Anyway, this confirms our inflationary thesis (hyperinflation, really) for the coming U.S. economy, where homebuilders and renters will feel the most pain.

How do we know? To get up to speed, check out this post on the full inflation trade breakdown.

Speaking of markets sending a message, let’s get on with today’s email 📧…

NO U-TURN AHEAD
Get the Hint Already

We need to talk about something before you go on and buy or sell anything else this week.

The market is not okay, which we’ve covered in our commitment to traders' analysis. Big commercial dealers are net short on stock indexes while going long on short-term bonds. 📉 

At the risk of repeating myself, all markets behave as if inflation in the 6-8% range is about to hit us in the head.

And the latest set of data and price action from real estate only confirms this further for us:

The week’s and month’s performance clearly shows that real estate investment trusts (REITs) are getting preferential treatment this go-round. In contrast, mortgage-related stocks get the short end of the stick.

Specifically, we’ve seen real estate services stocks come out winning for the week, which makes sense in our inflation scenario thesis.

Here’s why:

Since the small-cap index, the Russell 2000, has been flattening while the growth stocks ETF ($IVW) keeps making a new high 📈, markets are saying inflation is going to hit domestic stocks while the ones with international exposure make it out alright.

Then there are bond yields. They’re going up in a fashion not seen since post-COVID-19, and that tells me credit markets are going to be tight alongside inflation as well.

So, what you get is high mortgage rates with all-time high home prices 🏘️ as a result. In other words, it is an impossible market if you’re a first-time home buyer.

What was supposed to be the American Dream has become a nightmare. Buying a home at these interest rates and elevated valuations means you’re locking yourself up for a multi-million dollar sunken cost.

You’re better off investing that money somewhere else, trust me.

Even the homebuilders know there will be close to zero housing demand because of this; here’s a chart to make it make sense:

Building permits are now down for the month and for the year 📉. If you expect economic conditions to continue to tighten and new homebuyers to have a hard time getting a home, then why build more?

So far into the quarter, all homebuilding stocks have reported rising cancellations, so there are not only fewer projects in place but whatever projects survived are now being called off as well.

This is why you also see fewer housing starts, meaning no new construction is taking place as building permits dry up:

So remember, any time your realtor tells you that we have a housing shortage or that rates are going to come down soon, they’re wrong. If they knew anything, my friends, they’d be bond traders instead.

Speaking of shortage, here’s what that looks like today:

We now have 50% more listings 🏚️ than we did last year, which brings me to the final conclusion of this segment.

If you have the cash and live in leading markets like Florida and Texas, get ready for some incredible deals.

Why?

If nobody is buying homes, and everyone is now listing theirs because of the inability to pay mortgages, then you have a potential 40% decline 📉 in the average home price in your hand.

I am getting ready to buy some REIT stocks with high exposure to these markets.

Think:

• $EQR

• $CPT

• $MAA

More on those when the time comes, but you’ve been warned. 🫰 

 TRADE OF THE WEEK
Two Legs, One Spread

Considering the inflation trends we are spotting right now, we are bullish on oil stocks.

However, oil hasn’t performed accordingly lately, so we need to hedge our bets in case we are wrong or the trade takes a bit longer to play out.

Check out this post here for a full breakdown of why we think oil might be popping back up soon.

Here’s what the oil chart looks like compared to the $IVE / $IVW spread, which measures value stocks relative to growth stocks.

You’ll notice that this spread is the mirror image of oil prices. As this spread has been breaking down lately, it follows fundamental and technical reasoning to see oil come back up soon enough:

There are many other factors contributing to bullish oil, but that’s another post for later this month.

For now, here is our best-performing oil trade so far. That’s after we took profits on Chesapeake Energy stock a couple of weeks ago. 📈 

Antero Resources

This stock is one of the few in the oil exploration and production industry that still calls for a reasonable premium valuation, not to mention triple-digit EPS growth ahead.

Considering that the leading stock in this peer group, Chesapeake Energy, already trades at 92% of its 52-week high today, it’s time for Antero stock to catch up soon.

Trading at only 76% of its 52-week high and still pushing for massive EPS growth and a forward P/E premium to the peer group, we think the stock could deliver strong earnings results this week and give us a gap closure to the rest of the sector.

That’s for some of the fundamentals, now let’s get into the entry and exit levels based on what the chart looks like right now:

Unfortunately, if you can’t get the stock at the $25 level 🎯 again, which acts as a low-volume node cutoff, I don’t think you’ll be able to get it before the coming oil run.

That doesn’t mean it’s too late, but more on that later. Let’s figure out the different potential exit points for this long trade:

Ideally, we think an exit could be had around $35 a share, which is 27% above today’s price 🔥. However, in order to get to that high-volume node, we need to break through the cutoff $30 level.

Analysts at Bank of America rated the stock at a $36 valuation in late October, so we think we are thinking along the right terms. This would also bring Antero stock on par with the rest of the group when it comes to price action.

What if we’re wrong, though? How do we hedge this?

ARKK Innovation Fund

From a fundamental point of view, if we are right about our oil thesis, then growth stocks will fall due to the increased costs of, well, everything.

Given that ARK Innovation ETF has underperformed most of its peers during the past 12 months, we think it could be one of the first to roll over when and if bad news breaks out.

That makes all the sense in the world, but we still have to check what the statistics and technicals have to say about this trade on the short side.

These are the rolling correlations between the two stocks, Antero and ARK. Notice that correlations are currently broken down to the negative side 📉 .

Without getting too geeky, this essentially means that perceptions have shifted to drive these two apart.

After studying when and why this happens, I concluded that correlations between them break down when inflation fears are back on the table for the economy.

Bingo.

The ARK chart also looks like it’s heading into a low-volume node area, making it likely that a reversal will be on its way, the market profile would agree with this cutoff as well.

Speaking of the market profile, here’s what it looks like as far as a potential exit goes for us:

Initially, we are shooting for the $46 volume point of control 🎯 (thick red line) to test out whether we will see a longer-term drawdown in the stock.

Then, we’ll see how it behaves when it gets to the lower end of the profile, around $42 a share.

NOW GO AND MAKE IT HAPPEN
Good Enough for Two

This book has already made it to the recommendation list, but as I’m reading it, I find it increasingly interesting and useful, even after over 10 years of experience in the markets.

Today’s book recommendation 📖 applies to every investor and trader. Whatever strategy or discipline you may have, this book offers something to be learned.

To your success,

G. 🥃