Last month was definitely a December to remember, although the ribboned white Lexus parked in a snowy driveway was missing. Normally a low-volume, sleepy grind higher – both elements of the typical year-end Santa Clause rally – this December was the worst December in over 80 years; an unpleasant month for equities worldwide. Technicals remain challenged. The S&P 500 has been living below its 200-day moving average for many weeks now. Small caps and the Transports lost 20 and 19%, respectively, in the fourth quarter. Oil remains bidless, the Fed remains hawkish, and cracks in global credit markets are apparent. There seems to be too much volatility and zero conviction out there to prompt serious buying. One thing we have yet to see (in my opinion), and may need to see in order to establish a true bottom, is a capitulation in the form of a real spike in the VIX Index – a true spike in the cost of insurance and a panic around it. The VIX remained abnormally subdued vs. the amount of selling through the bulk of the month. With realized vol being so elevated throughout December, the price of options will likely remain elevated for a while longer regardless of what happens in the market (and, as mentioned above, the cost of insurance may need to get significantly more expensive before it gets cheaper).
Important Questions to Ask:
What are the positive catalysts that will end the selling and put a true and sustainable bid into equities? Will systematic strategies continue to sell rallies and get shorter? How much damage was done in December that has yet to become evident? Have valuations come down enough? Will real estate start showing signs of infection from the sickness in other markets? How much of the selling in December was a result of the previous ten years of monetary excess vs. the many other distractions people are blaming, such as the government shutdown and/or China trade? Will pension funds cut down equity exposure or use the current 15% drawdown from the highs as a reason to add net equity exposure?
Here are the updated key drivers that we see as most important in this market (in no particular order as they are all significant):
- WTI Crude has shed more than 40% since October: Oil continues to signal a slowing of the world economy. But is global growth crashing as much as the price of oil is signaling? Sentiment in the oils is awful. Huge players have clearly been unwinding their massive long exposure that likely took years to build up. The only thing more surprising than both the pace and size of this unwind might be, at the least, a near-term bottom that is not within a few bucks from current prices. The price action in oil over the next several months will be very important for all markets.
- Credit markets aren’t happy (at all): Some unnerving things are happening in credit. The spread between the 10-yr Treasury yield and 3-month Libor inverted in December (briefly, but surely). Leveraged loan funds saw their largest ever outflows in the middle of December. Equity investors continue to pay close attention to the noise rattling in credit.
- Where do things actually stand between the U.S. & China? If anyone knows the answer to this, please let me know!
- The leaders in U.S. equities, particularly in tech, have fallen: The big boys in tech – AMZN, AAPL, NFLX, NVDA, etc – have been slow to get up. The generals lead the soldiers, and the generals are wounded. Markets need the generals to heal and get back to leading the soldiers.
- Interest rates and the Fed: The Fed raised interest rates on the 21st of December, which was all but fully priced into the markets. What changed is this: Fed Chair Powell made it clear he’s not there to save the stock market. He anticipates two additional hikes in 2019, while the market wanted to hear one or none. It’s important to remember that even if rate hikes slow or stop, the Fed is still early in its balance sheet unwind, which is another means of tightening credit. Additionally, both 3-month LIBOR and the LIBOR-OIS spread are moving higher, not lower.
Other significant factors to watch: The Dollar/Yen carry trade is crowded yet detaching from the S&P 500, and both European and U.S. banks continue to trade very poorly.
Wennco Downshift ETF Update:
Since inception (July, 2018), Wennco Downshift ETF is -2.07% (net) vs. -6.86% for the S&P 500 Total Return Index. While we are encouraged with our 4.79% net outperformance vs. the S&P 500 TR since our strategy inception, we are happier in the ability of our strategy to execute (and even exceed) that which we set out to achieve: a hedged equity strategy that captures significantly less of the S&P 500’s downside vs. “the other” hedged equity managers, who seem to consistently capture 60-75% of the S&P 500 TR’s downside during risk-off months and quarters. In our opinion, Downshift is a more ‘hedged’ hedged equity strategy.