In the early 1900s a German scientist hypothesized the concept of the "Umwelt"; a simple word that expressed a concept so deep, but often overlooked -- stating "different animals in the same ecosystem pick up on different environmental signals." In summary, any given species would have an alternative worldview influenced by their biological disposition.
As the market violently whipsaws within a 10% range in a matter of a few weeks -- in a complete vacuum of "new" information -- we as investors have the task of sifting through "The Umwelt" as perceived and forecasted by the various organisms that live in our trading world ecosystem. Theories being posited currently suggest a trough in a secular bull market or a peak in a structural bear market: which is it? It depends what sort of an investor you perceive yourself to be, and your size.
As the S&P 500 struggles with the 2500 level, quite a few analysts have drawn an analogy of the performance at the start of this year to 2016: height of Chinese devaluation concerns, global growth selloff during the Fall of 2015 only to be salvaged by Chinese central banks as they ramped up their stimulus package. If one were to draw the other parallel, 2008 vs 2018, a more dire conclusion is drawn: asset class implosion across the board.
It all depends on the organism studying the markets and its trends. Those who have mastered their trading career with a "buy the dip" mantra firmly cemented into their psychology over the last decade might perhaps fall into the former camp. Those with a more seasoned resume might be tempted to fall into the latter. Truth to be told, there are similarities and dissimilarities in both instances. Past is not a guide to future performance, but it is a good reflection as to the sequence of events that can lead up to it.
How does one invest today? Regrettably the market is quite binary as of today. We have managed to bounce off the disastrous lows witness on December 24, only to flirt with the upper end of the downward trading range the markets have been in. Computer algorithms and chart specialists running billions of dollars in these strategies will be tempted to start selling the markets here. These algorithms are gaining more and more importance in the way markets trade and have a lot more capital behind them, hence it is important for the most seasoned of hedge fund managers to pay attention to their signals.
The way charts work is if there is no "incremental positive news," then the sell signal generated is valid and markets will sell down due to lack of buyers. However, if we do get new fundamental information, in this case a positive trade war solution between the U.S. and China or a more accommodative monetary/fiscal policy signal, then that would give enough ammunition for the markets to ignore those sell signals and break through sustainably higher.
No asset class or strategy can be looked at in isolation, they are all linked. Fundamentals, however do prevail, just the timing is delayed a bit. The only problem is if one has enough capital to withstand the volatility and survive.
For those who caught the market bottom on Christmas Eve, it is a great time to take profits and be flat, awaiting a better signal. For those still nursing their wounds from long positions that were beaten last year, it is a great time to reassess their fundamental valuation and earnings story to see if the long is still merited. One thing is clear, the rally over the last week has seen all the laggards of last year rally a lot more aggressively than the quality names. That suggests a classic short squeeze, not a fundamentally bullish recovery.
The oil market is another case of the Umwelt, depending on how you are placed on the supply chain. The market is slowly tightening as OPEC+ cuts go into effect, and judging by the rig count, U.S. shale production can be seen to be peaking here. Winter has started off unusually warm and distillate heating oil inventories are more comfortable this year than last. Demand is still the unknown driver here to suggest a buy or sell signal in oil.
WTI Oil may be supported at $45/bbl as U.S. oil companies struggle to profit from drilling new wells. But it can also very well stay in this range with tighter supply being offset by weaker demand. Speculative funds have cut their bullish bets in Brent down to 152 million barrels, down from almost 500 million barrels at the end of September, and close to the lowest since 2015. The market is a lot "cleaner" now in terms of positioning. The next few weeks will make it a lot clearer whether the oil trade is a buy or a sell.
In the meantime, any lack of resolution in trade talks held this week between the U.S. and China can see the oil price sold down aggressively back to the low end of its recent trading range -- around the low $40s WTI. Oil is cheap at these levels, but we need to see evidence of strong demand to generate a stronger buy signal, especially as we deal with lower demand prospects based on global economic data seen so far going into the first quarter.