Wow, wasn’t January a fun month! In my previous commentary, I tabled three potential scenarios for stocks during 2016. My pessimistic scenario saw oil prices staying lower for longer, the duration of which was positively correlated to the rising risk of a market meltdown driven by a heightened probability of a liquidity crisis. I placed a 30% chance of this scenario unfolding, but I didn’t think it would happen during the first two and a half weeks of 2016. Fortunately, we entered January with conservative gross and net exposure positioning, so our funds suffered only modest losses for the month.
True hedge funds proved their worth during 2015, and unless oil producing nations back off from their game of chicken, the value of running a hedged book will only increase in 2016. Markets are running out of good news bullets, hence risks are rising. The longer oil prices remain below $50, the higher the probability that a non-bank financial company or country dependent upon commodity prices catalyzes a negative event for stocks and further flattens the yield curve. In contrast, should markets anticipate $60 plus oil towards the end of 2016, equities will see vicious sector rotation that only the nimblest of managers will be able to capitalize upon. Want to place your bet on where markets go? Not me! While my team has put together a repositioning “play list” for our funds for when the world begins to “reflate”, entering 2016 we’re positioned for defence after delivering a strong year on the offence side of the ledger.
The circular argument being driven by the monetary policy musical chairs continued this week after Draghi failed to “beat expectations”. This logic suggests the late week rally in the € trims Europe’s outlook for growth, necessitating further QE which in turn drives up the USD and causes the FOMC to remain “dovish”. Keeping pace with this bouncing ball causes dizziness to the market follower while North American markets just plain gave up, finishing November either side of flat, amidst an increasing number of disturbing signals.
Back in mid-August, China frightened markets with unexpected market interventions, serving to damage the majority of investors and asset classes. Then one month later, in mid-September, the FOMC heightened those fears and the market’s decline by implicitly blaming China as the reason the FOMC didn’t hike rates. Then during the following two to three weeks, enough China-calming statistics were released enabling “bad to become good again”, especially when weak U.S. September jobs data came out at the beginning of October. Sprinkle on a dash of short-covering and year-end performance chasing, regardless of the fundamentals, and you had the recipe for a good October. The S&P 500 index had its fourth best October since 1928 and one that more than erased all of Q3’s decline.