The Stock Market has captured daily headlines since the October sell-off began. Declines do it every time. Stocks, in aggregate, ended the week in much better shape than they started. The same goes for Bonds. It started with rampant selling. Fear returned. By midweek, all of the November gains were erased. The price action has been incredibly volatile. Investors keep getting jerked around. We don’t see the volatility ending any time soon, but we do think there are further gains to be had into year-end. It’s our sense that Wednesday’s reversal higher was significant and a rally is forming. A bit of a trend change has developed. In October, any rally was aggressively sold and stocks just could not stay elevated. This week saw declines that were met with buyers and the sell-offs were temporary. A fast moving Market this is. Volatile it is.
This Market cares about trade. It cares a lot. The news flow on the subject has perhaps been more volatile than the price action for stocks. The conflicting stories often come from within the White House, where on one hand, Treasury Secretary Steve Mnuchin and Senior Economic Advisor Larry Kudlow have been taking calls and exchanging letters with their Chinese counterparts and are exploring a path to a trade deal which includes a meeting with the 2 Presidents at the G20 summit. On the other hand, the top trade advisors Robert Lighthizer and Peter Navarro have been squashing the optimism which is confusing pretty much everyone. Perhaps it’s a “good cop, bad cop” ploy, something that President Trump seems to enjoy. Navarro was reportedly muzzled this week and the President stated Friday that China wants a deal and the higher tariffs might not be needed in January. These pieces of news sent stocks higher. The Market indeed cares about trade.
The price of Oil has been smashed. It was rumored and later confirmed that a large Energy Hedge Fund got caught positioned the wrong way, making an aggressive bet that the price of Oil would rise sharply and Natural Gas would fall. The opposite occurred. West Texas Crude fell over 20%, from $75 to $55 and the fund was forced to liquidate many holdings, taking the fund down 20% in October. The rapid Oil decline sent shockwaves throughout the system, questioning whether global demand was falling off a cliff driving prices lower. The price of Oil has long been an important indicator of global economic growth. Supplies have been rising, but the new sanctions on Iran and a production cut by the Saudi’s should balance things out a bit. If that Energy Fund struggle was the cause of the Oil collapse and it is now done, then you might say look out above for Oil. Energy stocks, which got battered, led the charge higher the last couple days.
These are serious issues. These are serious times. There is no question about it. One thing we want to make clear: We see few signs of stress in the Financial system. The credit market continues to behave quite normally. Yield spreads have widened a bit, to reflect the increased volatility and risk. That is to be expected. But they are not showing any signs of economic recession and certainly not a crisis. High-Yield Bonds, a more glamorous term for Junk, have weakened of late, but Junk Bonds act more like stocks anyway.
Our focus is defense first. Protecting capital is our primary responsibility which we take extremely seriously. We look for opportunities to grow money in the form of capital appreciation and cash flow. We take calculated risks. There are many risks at play right now, economically, politically and geopolitically. We also believe that the Market has gone a long way to price in many of these risks. This is why an oversold rally is still our base case. But many of these risks could easily lead to serious and long-lasting problems. We all know it.
Heading into October, it seemed as though everyone expected a year-end rally. Investor enthusiasm was high. The recent selling has shaken that sentiment to its core. Investor sentiment, something we study closely, is very negative again. Right now, there are more Bears than Bulls. That usually occurs around Market lows before a rally occurs. November and December are normally the strongest months for stocks. But I know what you’re thinking: 2018 has been anything but normal…
Have a nice weekend. We’ll be back, dark and early on Monday.