The market is like a multi-dimensional matrix, each asset class representing a dimension with its own tale through its sequence of numbers in rows and columns, overlaid on top of another asset class, and so on. It is a dynamic story being told by the individual dimensions yet combining to make one larger story. After the global synchronized growth since 2004, asset classes can no longer be looked at in isolation. That is the power of stimulus and liquidity, it powers all asset classes together, both up and down.
The S&P 500 paints a boring picture on the surface. Yes, it has outperformed rest of Europe and Emerging Markets given its relatively robust growth profile. When one digs deeper, the sectors tell a different story. Most long/short funds can outperform traditional long-only funds if they get their sector allocation right, even if markets are flat. I suppose that is what the 2% and 20% fees are for, they need to be worthy of it. Since the middle of 2018, global growth has been slowing down and money has been coming out of equities overall as an asset class and into bonds and money market funds. Within equities, sectors such as Utilities, Consumer Staples and Healthcare have all outperformed the likes of banks, retail and industrials, and commodities. The former group represent bond proxies -- safe and defensive. The latter represent economically sensitive sectors and as things slowed down with the yield curve inverting, these sectors get hit the hardest.
In the weeks leading to the Fed's October FOMC meeting, investors were intoxicated by "hopium," as they expected the Fed not only to cut rates by 25 basis points (bps), which they did, but also expected Powell to keep going. After all, they did pledge to buy $60 billon per month of Treasury bills and inject about $200 billion in overnight repo operations, which is ongoing until Q1 2020. One can hardly be reprimanded for following the money, as the Fed opened the taps once again.
Judging by past experience, any form of a liquidity surge, call it QE or not, is money being injected into the system to stimulate growth -- like jumpstarting a car. For this reason, all cyclical economically sensitive sectors started rallying and closing some of the year's underperformance vs. the defensive sector.
The yield on the US 10-year, after falling down to 1.5%, rallied all the way back to 1.8% as the back end of the curve was sold hard -- re-steepening of the curve is usually a bullish indicator. This led to a massive selloff in bond proxy sectors like Utilities and Consumer Staples. The banks rallied hard, as any re-steepening of the curve is supposed to be a good omen for the sector. The question now is, is this the start of a new bull trend or just a dead-cat bounce into month and near-year-end?
The Fed in October turned out to be a tad bit more hawkish as they removed the phrase "act as appropriate to sustain expansion," saying they were comfortable with monetary policy for now. This indicated they were done cutting rates after this third time. However, the market still expected them to cut one more time this year and another couple of times next year. So, the Street is still quite dovish. During his press conference, Powell commented that only a significant increase in inflation would motivate the Fed to raise rates. The market cheered on this as "rates are never going up" -- and equities were bid, along with bonds and gold.
All in all, the Fed was hawkish and there should be a dollar bullish bias.
Now the baton is clearly passed to Trump and rests on his precious trade war with China. With the Fed on pause and market at all-time highs, Trump knows that if he decides to play hard ball, the market will fall and he will lose his precious stock market rally to show his great presidency.
China knows this too, as they know his hands are tied. What did they do? The day after China said they would only sign Phase 1 if tariffs were removed -- a fair demand. Also, Mnuchin came out admitting that China's agriculture purchases would be $10 billion-$15 billion and grow to $40 billion-$50 billion over time. If there was ever a lost in translation series, this would seriously be it, as I'm not entirely sure if Trump and Xi Jinping are on the same phone calls? My bet is on the former making up whatever he wishes in his head to get algos to buy the market.
When Fed cuts rates, it usually takes a bit of time for it to show up in the numbers positively, or it could be too little too late. The data in Q4 is off to a horrid start and numbers are getting progressively recessionary with every print from China -- and the U.S. now too. After the bounce in the last two weeks in cyclically oriented names, with the bond curve now flattening again as the U.S. 10-year yield fell down to 1.67% from highs of 1.8%, this suggests the bond market is convinced of a policy error of sorts. This sort of volatility is not good for any institution as their VAR models will start beeping.
Never trust the equity market as it is too simplistic a creature, swayed and pushed by any headline that takes its fancy. The more-sophisticated and mature markets like bonds and rates never lie and their reaction tends to be more a premonition than a knee-jerk reaction.
Overall economic growth is appalling, with a risk of China falling below 6% GDP. Cyclical stocks like industrials and materials, commodities like copper and iron ore and their respective equities look expensive given their recent bounce, including oil stocks that have rallied 10% off their lows in some cases.
The market may look boring on the surface, but is far from it.