Amid The Worst Stretch Of The Year For US Stocks, The Real Question Is: Why Isn’t It Worse?

This was yet another week when things could have been worse.

True, Friday’s half-hearted, pre-holiday rally wasn’t enough to keep the S&P from logging its first three-week losing streak of the year and the Dow fell for a fifth straight week, the longest stretch of weekly losses since 2011. That said, considering recent events on the trade front, “resilient” seems like a reasonably accurate way to describe equities – at least in the US. On Wednesday, Nomura outlined a series of factors that may be helping to ensure the bottom doesn’t fall out entirely, no matter how many times Trump tweets. “It continues to look like stocks can’t really ‘sell off’, as we see a number of flow catalysts for ‘rolling squeezes’ despite the deteriorating macro and trade”, the bank’s Charlie McElligott wrote. “There’s plenty of room to add from systematic / vol-sensitive buyers, all at a time when VIX roll-down strategies are again in position to sell vol. with the term structure back neatly in contango, while too we are seeing the gradual return of systematic vol. sellers which not only means pressure on vol., but also then creates dealer Delta to ‘buy'”, he added.

That doesn’t mean there aren’t pockets of trouble – there are, with semis being perhaps the best example. The SOX has fallen in six of the last seven sessions, as concerns around the Trump administration’s efforts to crush Beijing’s tech ambitions reverberate across the global technology supply chain.

Meanwhile, energy stocks have been hammered. It looks to me like the sector has fallen for seven consecutive weeks, with this week being particularly rough as investors ponder the prospect that Donald Trump’s “greatest” trade wars will precipitate a global growth slump, leading directly to demand destruction. Between growth jitters and rising US stockpiles, WTI has fallen back below $60. Despite myriad supply risks (from Venezuela to Iran) and the OPEC+ “put”, this was the worst week of the year for crude.

Growth jitters have also showed up in bonds – and “big league”. 10-year yields in the US fell to their lowest since 2017 this week, as shrill rhetoric from Chinese state media and a smattering of lackluster data underscored worries about the outlook for the global economy.

Read more: Misery.

There does seem to be a lot going on, but, again, for all the geopolitical tumult (which now includes a leadership change in the UK just as the EU elections are going on, a new deployment of US troops to the Mideast amid worsening tensions between Trump and Tehran and, of course,  a constitutional crisis unfolding in Washington), US stocks have yet to truly buckle.

If you’re looking to explain things, you might simply note that, as Deutsche Bank’s Aleksandar Kocic writes on Friday, equities have adapted to the post-crisis environment. To wit, from Kocic:

Why are equities so calm if the most plausible outcomes of the trade war are all bearish for growth? Global growth slowdown and strong USD are generally not supportive for risk assets. However, equities have learned how to thrive in such environments. After all, we had almost a decade of sub-average growth and problematic recovery when excess accommodation pushed equity performance to near all-time highs. As if all equities need is excess liquidity (for the same reason, stocks have perceived rate hikes as the most significant headwinds). Thus, it comes as no surprise that the current equity repricing hasn’t been accompanied by a rise in vol risk premia. One way or another, the market seems to believe that equities would be all right — either the trade war risk is diffused or, in the case of its deepening, there is an accommodative Fed on the sidelines.

It would be difficult to put it any more succinctly than that.

As far as rates go, Kocic notes that at least in the vol. space, rates are skeptical about the idea of an all-out trade war. Again, Aleks’s take is straightforward and eloquent. Here’s the relevant passage:

Rates volatility, however, seems to be rather skeptical regarding the further deepening of the trade war. Not only is the vol market refusing to put a premium on a large rates rally, but also it is all but ignoring the rates moves of the past month. Based on simple linear logic (which might easily prove to be the wrong metric to use under the present economic and political constellation), one has to have some sympathy for this interpretation. After all, deepening of the trade war takes us deep into the territory of suboptimal decisions, where no path leads to positive outcomes. It is not clear who could benefit from such an approach — everyone is likely to be worse off; the only question is by how much. 

Indeed. But as Kocic alludes to, “linear logic”, may not be the best way to think about things under the circumstances. You don’t have to be a master at reading between the lines to know what he’s driving at there.

Still, if there’s anything Trump does care about it, it’s his ego, which would be severely bruised if a recession were to come calling. He’d find scapegoats (e.g., the Fed) but an economic downturn would undermine his claims to legendary business acumen, if they haven’t been undermined enough already by the myriad investigative reports documenting the president’s dubious track record.

Additionally, a recession in an election year would be particularly unpalatable. As Kocic puts it, “it is difficult to see how taking the risk of owning a recession ahead of elections can be a sound political strategy.”