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Stay Nimble Out There: Looking Ahead to April

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March Recap & Looking Forward:

On the heels of a truly risk-off Q4 2018, Q1 2019 was completely risk-on:  The S&P 500 Total Return Index gained over 13%, crude oil tacked on over 32%, and high yield added over 7%.  Likely factors that drove Q1’s outsized returns (aside from the newly ‘returned’ dovish Fed): Investor positioning was defensive going into Q1.  Positioning has an important – and often overlooked – role in markets ‘doing what they do’.  The losses experienced in equities around the world in Q4 were fresh enough to warrant fund managers being under-allocated (or not max long) to stocks at the start of Q1.  As this cash/rotation into equities comes into the market, it supports buying the dips (even the few mini-dips that were presented in Q1).  The next group of significant Q1 buyers were likely corporations via buybacks.  These buyers are often price-insensitive and have certain windows in which they must buy back their stock.  As Q1 earnings season is about to ramp up, most of these corporations are now restricted (or will be within a matter of days/weeks) from buying their stock until shortly after they report (the blackout window is now starting).  Short covering and risk-parity funds also added to the buying pressure.

Looking ahead, signals pointing towards future market volatility are building.  Corporate earnings growth is slowing (or perhaps stalling), equities have become more expensive over the past 90 days, shorting volatility (looking at VIX futures positioning) has returned to levels that preceded the unwind in risk-assets last fall and last February.  There are less bullets in the Fed’s holster.  Maybe no bullets?  With that being said, two things are clear:  1) don’t fight the Fed is alive and well, and 2) bonds and equities (price action) are telling two very different stories about growth (recent, present and future).  Many eyes and ears will be watching and listening to results and guidance from upcoming earnings prints, guidance, and conference calls – mine included.

WTI Crude Oil, S&P 500 Total Return, and HYG (High Yield Bond ETF) Q1 2019 COMPS:

Wennco: WTI Crude Oil, S&P 500 Total Return, and HYG (High Yield Bond ETF) Q1 2019 COMPS

VIX Net Futures Short Positioning (Similar levels to Jan/Feb 2018 & Sept/Oct 2018)

Wennco: VIX Net Futures Short Positioning (Similar levels to Jan/Feb 2018 & Sept/Oct 2018)

More Thoughts on the Markets:

Throughout this V-shaped rally, fundamentals and global growth have continued to wane.  Whether or not the current growth-rut is mostly (or all) trade related is a tough argument.  Certain parts of the yield curve have clearly inverted.  Much of the media is fixated on the 2-10 curve, and since that hasn’t inverted, there’s no problem (or foreseeable one).  My opinion is that yield curves – any portion of them – don’t often invert and never invert for positive reasons.  While history points out that inversion isn’t the end of risk assets going higher (in fact equities often have a final thrust upwards after inversion), it has been reliable in communicating that things are changing and this cycle may very well end within 12-18 months, or less.  From a different prism, markets – at the moment – are completely fine with bad data.  If the Fed is accommodative, then “bring it on.”  Additionally, many reputable economists and research firms believe that a sharp rebound in economic data is just around the corner.  Focusing on the present: global growth is weaker today than it was in January and September of last year, which were the “on-deck” months before swift and significant drawdowns in equities commenced.  Bulls will argue that this time is different:  the Fed was hawkish then vs. dovish today.  Valid point.  Bears will argue that growth and expected future growth – for both the economy and corporations – will ultimately decide where we’re going (and both incoming data and the yield curve point to a slowdown).  Valid point.  The tug of war continues, but right now the bulls are winning the technical battle.  2800-2825 is an important range for both sides.

U.S. Treasury Yield Curve (Inversion within parts of the curve)

Wennco: U.S. Treasury Yield Curve (Inversion within parts of the curve)

Retail Sales (Consumer spending makes up the majority of GDP – roughly 70% – and if the consumer isn’t spending, the economy isn’t growing, period.  Important indicator to watch).

Wennco Retail Sales

Negative-Yielding Global Debt is Above $10 Trillion

Negative-Yielding Global Debt is Above $10 Trillion

PE Ratio on the S&P 500 Has Repriced Meaningfully Since late-December, and This Can Continue

Wennco-SPX-Index

Here are the key drivers that we see as most important in this market (in no particular order as they are all significant):

  1. U.S. – China Trade Talks:  Lots of talk with little action has appeased markets lately.  This can’t go on much longer…or can it?
  2. Oil is Holding Steady over $50/bl:  Higher oil prices with slower growth isn’t a good combination, and that’s where we are today.  Away from that, $50 remains a key level to hold for all markets, especially high yield. 
  3. Earnings and Guidance:  Q1 earnings are on deck.  Guidance will likely be the most important factor as markets are expecting lackluster earnings for the first quarter.
  4. Interest rates and the Fed:  The Fed refused to end the current cycle in 2016 and seems adamant on trying to avoid it again now.  The Powell put is newly formed – but its strength and reliability is TBD.  After all, he went from hawkish to dovish on a dime.  Powell pivoting back to hawkish if the data picks up isn’t far-fetched.  But without strong data, the odds of a rate hike(s) for the balance of 2019 is close to zero.  And even if growth picks up, the odds of a rate hike(s) this year still seem near zero, as rate cuts are being ‘requested’ by some very influential individuals. 
  5. Debt:  Debt quality is deteriorating at the same time debt levels are very elevated.  While there has been some deleveraging in households and the much of the banking sector since 2008, both corporate debt – away from financials – and debt to GDP are at nosebleed levels that can add fuel during the next bear market.  

Wennco Downshift ETF Update:  

In the 9 months ending 3/31/2019, Downshift ETF has returned -0.35% (net of Wennco fees) vs. 5.84% for the S&P 500 Total Return Index.  The Strategy remains well-hedged and in a position to take advantage of future volatility.

Downshift ETF was designed to help advisors reduce the volatility of their clients’ portfolios while remaining invested.  We firmly believe that owning uncorrelated assets is the only way to truly hedge against market risk, and, today, markets are roughly 10 years into this historic cycle, and 3 months into a very strong rebound after a dismal Q4 2018.  Odds are high that the risk/reward profile in equities are skewed differently today vs. most times over the past decade – and limiting downside risk should be in focus and prioritized as much as maximizing the upside.  Downshift ETF has two parts which are negatively correlated:  long-dated and actively managed S&P put options and actively managed covered calls.  Owning both market beta (direct correlation to the S&P), along with uncorrelated return sources, is a prudent way to grow assets over time.

Downshift ETF is available to invest on Schwab’s Marketplace Platform.  Our latest 2-pgr can be found here:  https://www.wenncoadvisors.com/wenncodownshift-etf-strategy

From a sector positioning standpoint, we continue to add to MLPs on pullbacks.  There has been a notable improvement in fundamentals in the space and a declining correlation to oil prices, as many MLPs are working towards reducing their commodity price exposure.  The yields on MLP baskets (AMLP is the ETF in Downshift) generate higher income vs. most high yield bond baskets, and have a stronger current fundamental and credit-risk backdrop than high yield bonds currently carry (in our opinion).

MLPs vs WTI Crude: Declining Correlation

Wennco-MLPs-vs-WTI-Crude

Source: Bloomberg & Wennco

 

 

Sector/ETF Charts of the Month:

This month I charted the ratios of sector ETFs vs the S&P 500 over the past 1yr (illustrating which sectors and ETFs are currently expensive or cheap relative to themselves vs. the S&P over the past year).  These are useful to gauge which sectors/ETFs might be due for a catch-up trade, and which sectors/ETFs appear overbought and might due for some mean-reverting.  I’m happy to chart and send longer-term ratios of the below, just let me know.

 

Wennco-XLK-SP-500

Source: Bloomberg & Wennco

XLK (Tech)/S&P 500 1-yr Ratio (98th percentile)

Wennco-XLV-SP-500

Source: Bloomerg & Wennco

XLV (Healthcare)/S&P 500 1-yr Ratio (51st percentile)

Wennco-XLY-SP-500

Source: Bloomberg & Wennco

XLY (Cons. Discretionary)/S&P 500 1-yr Ratio (83nd percentile)

Wennco-XLI-SP-500

Source: Bloomberg & Wennco

XLI (Industrials)/S&P 500 1-yr Ratio (38th percentile)

Wennco-XLF-SP-500

Source: Bloomberg & Wennco

XLF (Financials)/S&P 500 1-yr Ratio (1st percentile)

Wennco-XLP-SP-500

Source: Bloomberg & Wennco

XLP (Cons. Staples)/S&P 500 1-yr Ratio (71st percentile)

Wennco-XLE-SP-500

Source: Bloomberg & Wennco

XLE (Energy)/S&P 500 1-yr Ratio (4th percentile)

Wennco-Vox-SP-500

Source: Bloomberg & Wennco

VOX (Communication Services)/S&P 500 1-yr Ratio (10th percentile)

Wennco-XLU-SP-500

Source: Bloomberg & Wennco

XLU (Utilities)/S&P 500 1-yr Ratio (82nd percentile)

Wennco-KRE-SP-500

Source: Bloomberg & Wennco

KRE (Regional Banks)/S&P 500 1-yr Ratio (2nd percentile)

Wennco-IYM-SP-500

Source: Bloomberg & Wennco

IYM (Materials)/S&P 500 1-yr Ratio (2nd percentile)

Wennco-MLPs-SP-500

Source: Bloomberg & Wennco

AMLP (MLPs)/S&P 500 1-yr Ratio (10th percentile)

Wennco-VNQ-SP-500

Source: Bloomberg & Wennco

VNQ (Real Estate)/S&P 500 1-yr Ratio (91st percentile)

 

I hope everyone has a great April.  Stay nimble out there.

Best,

Chris

Chris Wenner
CIO & Head Trader
Wennco Downshift Strategies

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