Wednesday, January 19, 2022

Morning Note: Mid-Terms are Tough

The following from BCA Research emphasizes a few assertions we've been making lately:

1. That currencies are not always all about interest rates.

2. That value stocks presently offer more appeal than growth.

3. That overseas markets have potentially more to offer relative to the US.

4. That, as we've been pointing out in client meetings, mid-term election years can be tough on US equities.

emphasis mine...

"The key driver of equity markets is profits in the short run, with valuation starting to matter over the longer run. This in turn becomes the key driver of cross-border equity flows. These flows help dictate currency movements. For much of the previous decade, US profits did much better than overseas earnings. For this reason, the US equity market outperformed, pulling the dollar up, as foreign equity purchases accelerated.

The post-pandemic era has seen inflation rising across the world, changing the paradigm for US profits. High inflation, and consequently, higher bond yields, have been synonymous with an underperformance of US profits. Banks profit from higher rates, as they benefit from rising net interest margins. Materials, energy, and industrial stocks, benefit from higher inflation via rising commodity prices that boost their pricing power. In a nutshell, rising inflation tends to be better for value stocks and cyclicals, sectors that are underrepresented in the US. This means portfolio flows into US equities, one of the key drivers of the capital account surplus, could be on the cusp of a substantial reversal.

The key point is that the US equity market has been the darling of the last decade, and leadership is at risk from higher rates, via a reset in both relative valuation and relative profits. So, while the US market could perform well in 2022, higher rates could undermine its relative performance to overseas bourses. This will curtail equity portfolio inflows, as capital tends to gravitate to markets with higher expected returns.


Asian equities struggled notably overnight, with 13 of the 16 markets we track closing lower.

Europe, on the other hand, is seeing a nice rally so far today, with all but 2 of the 19 bourses we follow trading higher as I type.

US major averages are mixed: Dow down 89 points (0.25%), SP500 up 0.02%, SP500 Equal Weight down 0.32%, Nasdaq 100 up 0.39%, Nasdaq Comp up 0.26%, Russell 2000 down 0.77%. 

The VIX sits at 23.06, up 1.18%.

Oil futures are up 1.16%, gold's up 1.28%, silver's up 2.03%, copper futures are up 1.85% and the ag complex is up 1.03%. 

The 10-year treasury is up (yield down), and the dollar is down 0.15%.

Led by silver, uranium miners, Latin American equities, gold and ag futures -- but dragged by MP (rare earth miner), energy stocks, bank stocks, ALB (lithium miner) and carbon credits -- our core portfolio is up .09% to start the session.

It's my observation, for the most part, that investors are forever in search of a catalyst that might bring pain to the equity markets. Clients will recall that we began actively hedging portfolios back in late-summer 2019, not because we had any clue as to what might turn out to be a market-wrenching catalyst, but because our overall assessment of general conditions rolled over. I.e., the overall risk/reward setup instructed us to buy some protection. A move we were very glad we made come the spring of 2020.

Here's Didier Sornette, in his enlightening book Why Stock Markets Crash:   emphasis mine...
"...the underlying cause of the crash will be found in the preceding months and years, in the progressively increasing build-up of market cooperativity, or effective interactions between investors, often translated into accelerating ascent of the market price (the bubble).

According to this “critical” point of view, the specific manner by which prices collapsed is not the most important problem: a crash occurs because the market has entered an unstable phase and any small disturbance or process may have triggered the instability."

"The collapse is fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary."

Have a great day!

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