Trying to Figure Out Stocks
Trying to figure out why stocks went up or down on any given trading day is a fool’s errand (yet that obviously doesn’t stop the mainstream media).
There are a few major narratives, however, that I believe to be responsible for what is now the worst start to any year in stock market history, at least to some degree or another.
So here are what I consider the stock market’s trending topics so far in 2016:
- The first and most obvious has to be the continuing crash in the price of oil(NYSEARCA:USO). Why is this a big deal? Because the longer prices remain depressed the more the market may be telling us weak demand for oil is just as important as elevated supply. In other words, the global economy may be weaker than most people thought just a couple of months ago.
- The oil crash and lack of any rebound at all so far is also a big deal because it’s unlikely that growing problems in energy credit will be contained within the energy sector. It’s more likely that energy (NYSEARCA:XLE) is just the canary in the coal mine for a turn in the overall credit cycle. Furthermore, credit usually leads equities.
- Another narrative I’m seeing much more of lately is the idea that sovereign wealth funds are liquidating their holdings of risk assets including both corporate bonds and equities. This is also related to the energy issue as many of the sovereign wealth funds attribute all of their wealth to the high oil prices of recent years. With oil now under $30, that wealth is now at risk as are all the assets they have accumulated over that time.
- Outside of oil, investors are also increasingly worried about a dual credit/currency crisis in China. Yes, trade with China only makes up a small amount of our economy. But, as the second largest economy in the world, it is also a key trading partner for all of our key trading partners. To assume any weakness in China would be “contained” is probably naive in this day and age of increased globalization.
- It’s also becoming more and more obvious that our own economy is not doing so hot lately. Industrial production (NYSEARCA:XLI) and growth in retail sales (NYSEARCA:XLY)have fallen to levels not seen since the last recession. Additionally, both the stock and bond markets are currently suggesting recession is a growing possibility.
- Finally, I’m also starting to see more discussion surrounding the idea of herding in the markets. The growth in price-insensitive buyers (including indexing, risk parity, trend following, momentum, etc. along with corporate buybacks and central bank buying) in recent years is greater than anything we have ever seen before and they have been at least somewhat responsible for pushing the valuations of risk assets to extremes also never seen before.
- What are the consequences of this sort of herding? The very same psychology that causes an investor to embrace these strategies in the first place, eventually leads them to abandon them when they fail to work as they hoped. It’s fear and greed at work in strategies as opposed to assets. We may now be entering the fear/liquidation cycle for price insensitive buyers which will inevitably lead to greater volatility and liquidity challenges.
How much of these market narratives are real versus imagined by market participants? And how much is now priced into the markets? Those are the trillion-dollar questions. The more successfully you can answer them, the more successful you will be in navigating the rest of the year.
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