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

"Why are equities so calm if the most plausible outcomes of the trade war are all bearish for growth?"

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.”


 

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

  1. Peter Schiff in his latest podcast episode makes a good point….if there ends up being some defaults on big name companies (i.e TSLA) then you might see a domino effect because Junk rates aren’t priced much higher than treasuries… As was mentioned above…there has basically been 10 years where investors can stay long through everything and still keep doing well year over year through all sorts of “risky” events that didn’t really end up amounting to anything.

  2. Good post and a good question. I would suggest another driver of the strong/resilient market performance: Trump has a lot of support among people who are invested in the market and their portfolios are still showing very healthy gains. And…Trump is a bully and a coward — which is what some people call the art of the deal. I am certain Trump will cave before Xi and the CCP does. But beware the black swan — this could all go south in a hurry.

    • Marko’s explanation is spot on: A Trump collar. Despite Trump’s bullshit bravado, I think he knows that a 3 percent-5 precent decline in the Dow (not S&P) drives his already high unfavorables into dangerous territory. A 5 percent- 10 percent decline going into 2020 seriously weakens his support among the gutless Republican pukes in Congress. A more than 10 percent decline into 2020 and he loses and ends up in jail, along with his obnoxious son Gumby Jr. At the end of the day, the stock market is the only thing that gets Trump reelected. (There aren’t enough bigots and racists in Michigan, Pennsylvania, and Wisconsin to do it a second time.) Cadet Bonespurs will cave in the trade war, and Xi knows it. Long Huawei.

  3. Observations

    SP500 has made 2 attempts to exceed the Jan 2018 highs and had not been able to sustain that level so 2850-2950 seems to be the limit at this time. That is concerning esp if this economy is the “greatest” ever.

    Yet the DJ Transports have been been unable to test, let alone, recapture the Sept highs and broke down hard this week. 10 year bonds to 2.3% when one can get 2.2% in an online bank savings account?!!! I believe both of those are speaking but one has to listen.

    Why haven’t investors listened? I don’t know. Maybe the Fed saving them every time the market sneezes. The buy and hold siren song has worked for 10 years. And go to bonds or cash? Unthinkable esp if one is trying to boost retirement accounts.
    Besides the market always comes back, just have to hold on, dollar average….ask the Japanese who have been long and underwater since 1989.

    Things work…until they don’t….;)

  4. The battle is between Trumps desire for the DJIA to be moving upward (Trump’s “proxy” for the economy) versus his desire to “win bigly” the trade war versus China. It’s the Trump “put” vs. Trump’s ego. The stock seems to be siding with the put, at least for the moment.

  5. Buybacks! Corporations buying $Billions of stocks. Without buybacks, this market would be toast.

  6. There is a huge difference between being perplexed or surprised by this market behavior and offering an articulate creative explanation, Indeed we have all seen this before in 2000 and in 2009 where equities for the longest time defy the laws of reason and also gravity.. I was out in both cases ,,,call it luck or chickens…s..t with cold feet… That having been Charlie get the prize for best creative articulation … H …you can share for repeatedly alerting us….of the perils……This time is no different even with a ‘madman” at the helm…(Trump) offset by the ranks of his insane base as well as Kudlow, Bolton and Pompeo… The Tina effect and the daily dose of anesthesia …. gives you what we have today..
    Holy Schmoley….is this for real or one of Shakespere’s dreams scenarios….

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