“Oi, get your filthy hands off my desert!”

361 Capital Market Commentary | September 16th, 2019

Roger Waters’ famous lyric from The Final Cut seems like an appropriate pivot for the market’s new attention toward the Middle East. It is not everyday that oil prices spike 10% due to a shutdown in 6% of the world’s oil capacity. I know that I am not the only one surprised at how easy it was to use drone weapons to impact global oil prices. This weakness will need to be addressed quickly or else Saudi Arabia will lose its reliability as a swing source of oil in the future.

As oil prices settle higher this week, they will be joining hotter-than-expected PPI and CPI results from last week. Very interesting timing for the Fed who will meet this week to (most likely) cut the Fed Funds rate by 25 basis points. This follows on the heels of the ECB last week who elected to accelerate quantitative easing in Europe through lower rates and further bond repurchases. The ECB is focused on getting inflation up and they are employing every tool aside from dropping Euros from drones. The U.S. is not there yet, although several of the Democratic candidates from last week are close to ‘going Oprah’ on Americans in order to win the nomination. And you thought last week’s $1 trillion budget deficit was big.

If it weren’t for the emergency in oil over the weekend, all that we would be talking about this week would be the rotation out of Momentum and into Value. It was a notable, epic move that will likely mark future shifts in portfolio style and factor weightings. What was the root cause for the sudden shift? It wasn’t one thing in isolation, but instead several sticks that collectively broke the market’s pinata. To set the stage, we know that several market strategies were well stretched (e.g., Growth versus Value, Momentum versus Chronic Underperformers, Low Volatility versus High, etc.). Also, the bond market had its own big momentum as a result of Central Bank buying and growing recession fears. So, when some slightly better-than-expected global economic data and hotter inflation data hit last week, combined with news that China and the U.S. could re-engage on trade talks, it was as if several fuses were lit. Not only did short investors rush to cover their best-performing trades and strategies, but new longs used the notable event to start legging into Value and Cyclical positions. Given how stretched some of these rubber bands were, the trades effects were substantial. Think of all the short energy positions from a week ago which were likely stopped out by the rotation last week. Had those positions still been on the books of some hedge funds this weekend, there likely would be some blood on Wall Street today.

So where do we go from here? At a minimum, uncertainty rises as we don’t know the extent of the world’s oil production damage. But once we do, oil price volatility will still need to be priced higher than it is today until their is more proof that this is an isolated incident which will not occur again. For consumers and businesses, the cost of everything will go up as higher transportation costs ripple through the system and we all pay more at the gas pump. The timing of a 10% spike in fuel costs is not good as economic data points and consumer and business confidence is slowing. A silver lining would be that the U.S. energy production complex gets another shot at survival and many of those single digit stock prices can evaluate their options.

The week that momentum corrected hard…

 

The last two times we’ve experienced a momentum breakdown this severe, it preceded or coincided with an economic recession. (Morgan Stanley)

US Pure Momentum Total Return

(WSJ/DailyShot)

The market was set up for a big rotation given how defensive and bearish it was positioned…

 

Components of BofAML BB Indicator
(BofA Merrill Lynch)

Hedge fund short positioning had likely gotten massive…

 

Hedge Fund Equity Beta
(J.P. Morgan)

So when the tide turned, short covering was the first button hit…

 

Performance of Top Bottom Quintile of SP500

(WSJ/DailyShot)

And as the market rotation ball got rolling, value stocks and small cap stocks ended up on top…

 

This all makes sense given how oversold these two styles have gotten over the last month. Now the question is, can they continue to attract incremental dollars going into new equity buying?

Style and Size

(Goldman Sachs)

Barron’s take on the Great Rotation…

 

It used to be that stocks that got too expensive would eventually sell off, and that stocks that sold off too far would rebound. But over the past decade, pricey momentum stocks have gotten pricier, and value stocks have stained the carpet. Then, during the first three days of this past week, momentum stocks sold off by 10% and value stocks rallied 7%, according to J.P. Morgan. That was one of the sharpest such three-day shifts in 30 years…

UBS explains that growth stocks have had such strong price momentum because investors have poured money into growth mutual funds at a time when fast-growing companies are becoming scarce. If history is a guide, a recent slowdown in manufacturing signals that growth stocks will now begin to underperform defensive ones, the bank says. It favors staples, health care, utilities, and real estate investment trusts.

Meanwhile, assets in stock index funds, which tend to have a momentum tilt, just eclipsed those in actively managed funds, according to Morningstar. If the recent bounce in value stocks is a hate rotation, savers are still boarding the love train.

(Barrons)

 


Violence in growth versus value has tended to be unfavorable for the overall market move…

 

@mark_ungewitter: Growth vs. value, 2-day rate of change. $IVW $IVE $SPX

SP500 Growth Value

Bond yields hit a nasty speed bump last week while on their way to zero percent interest rates…

 

Bond Yields
(@LMT978)

CapEx plans continue to show signs of slowing…

 

NY Fed Manufacturing

And new export order trends will pull future U.S. manufacturing lower…

 

@MylesUdland: DB’s Sløk: “The data speaks for itself, the trade war is having a serious negative impact on the US economy.”

Downside risks to ISM in coming months

Today’s big move in energy prices will make things even more difficult for manufacturers…

 

Light Crude Oil Continuous Contract

Credit investors likely became more concerned about a U.S. recession given today’s +15% move in oil prices…

 

Probability that the US enters an economic recession
(BofA Merrill Lynch Credit Investor Survey)

Why we watch jobs data so closely…

 

Great chart from ASR. Equities beat bonds as long as unemployment is falling. Run for the hills when the UE rate begins to rise.

The unemployment rate and global equities vs bonds
(@asr_london)

A recession is bound to happen. Here is what to prepare for in your large cap equity performance…

 

Histogram of SP500 declines around recessions
(J.P.Morgan)

Interesting that consumers are more likely to believe in a recession occurring in the next 12 months…

 

Most Americans rate economy positively
(WashingtonPost)


The only people more hopeful than ECB bankers are Cleveland Browns fans…

 

They keep trying and trying and trying to get inflation to their 2% target.

The ECB continues to predict a recovery in inflation towards the near -2% target
(WSJ)

Ford debt downgraded. GM goes on strike. Oil prices soar.

 

U.S. auto companies had better hope that oil prices return to normal or else they won’t be able to discount the gas guzzlers low enough to make a profit.

In 2019, S.U.V.s and pickups are grabbing a record 70 percent of the market, with 5.9 million sales through June versus 2.5 million for cars. Sales of midsize sedans have nose-dived, from 3 million in 2012 to 1.9 million last year. One of every five cars sold was a midsize sedan in 2012; today it’s barely one in 10.

As a result, Ford and Fiat Chrysler have decided to stop making conventional family sedans and compact cars almost entirely. Exceptions are made for enduringly popular muscle cars like the Ford Mustang and Dodge Challenger. General Motors hasn’t said it will abandon the car market, but it is killing off several money-losing sedans and hatchbacks, including the plug-in hybrid Chevrolet Volt.

(NYTimes)

Finally, I bet you didn’t see this coming…

 

Vinyl is set to outsell CDs for the first time since 1986, a new report reveals.The revelation comes in a mid-year report from the Recording Industry Association of America.

Last year’s RIAA report revealed that CD sales are dying three times as fast as vinyl sales are growing, and it’s more of the same in this year’s.

The new report states that vinyl records earned $224.1 million (from 8.6 million units) in the first half of 2019. This figure is impressively close to the CD numbers ($247.9 million, 18.6 million units).

With vinyl revenue growing by 12% in the second half of 2018 and first half of this year, and CD rates barely changing at all, it could see vinyl revenue overtake that of CDs by the end of the year.

(NME)

Vinyl

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