Market Expects Fair Winds and Following Seas

The markets got a taste of a risk-off environment last week. They quickly shrugged off a brief period of hedge fund balance sheet de-grossing to make new highs despite fears and worries about a deep correction. Indeed, one of the large investment banks had a note that suggested that last week was the largest period of de-grossing since February of 2009.

As seems to be the norm, the markets climbed the proverbial wall of worry and have quickly shrugged off the minor correction. The S&P had a big week, and closed up 4.6 percent. Similarly, the NASDAQ closed the week up 6 percent. The rally was indeed broad based, and the Value Line Index closed up 6.1 percent. The CBOE VIX Volatility Index closed last week at 33.09, and closed this week at 20.87, clearly indicating that fear has receded. Earnings season is fully underway, and there are signs from many companies that the economy is beginning to heal from the COVID-19 crisis. In addition, it would appear that Congress is getting closer to passing a $1.9 trillion-dollar stimulus package. Prospects for an economic recovery are also boosting rates, and we saw a steepening in the yield curve this week. 

Hopes for an economic recovery have helped cyclical sectors in particular. The S&P Global Natural Resources Index was up 3.5 percent for the week. Oil especially had a very good week. WTI Crude was up 8.9 percent for the week; Brent Crude closed the week just shy of $60. Although it is too early to tell, thus far producers have not increased capital budgets and production estimates in reaction to higher pricing. Continued supply discipline bodes well for more sustainable pricing close to the marginal cost of production, although we are watching the rig count tick higher with interest.

OPEC discipline has further helped buoy the energy markets, as have expectations of demand recovery. The rally in energy pricing created outperformance in energy related equities. The S&P Oil and Gas Exploration and Production Index was up 6.6 percent. The OIH Oil Services Index was up 7.5 percent. The XLE S&P Energy Index was up 6.8 percent. Natural gas had a massive week on demand concerns related to an “Arctic blast” across much of the United States. Other industrial commodities were less ebullient. Doctor Copper was off 1 percent and currently hovers around unchanged after a volatile year thus far. Iron ore was off 8.5 percent for the week despite the world’s largest producer showing falling production sequentially. Nickel was off 1.1 percent. Zinc, one of the worst year-to-date performing commodities, was up 1.4 percent.

Precious metals had a challenged week in a risk-on environment. Gold was off 2 percent for the week as it continues to hover around the $1,800 level, plus or minus. The AMEX HUI Gold BUGS Index performed decidedly better, and closed the week up 2 percent. Operational updates from companies thus far suggest a return to a more normal operating environment, albeit a new normal around social distancing and slightly higher costs for PP&E and other measures to facilitate worker safety from the COVID-19 virus. Junior gold stocks performed decidedly less well, and the GDXJ Junior Gold Miners Index closed the week off 4.1 percent. Silver had a challenged week, as well. It closed down 2.9 percent for the week after a meteoric rise and fall due to the ill-fated and ill-advised attempt by the Reddit/WSB crowd to gain control of the silver market and create a short squeeze.

More defensive hard assets sectors performed well, although less well than the broader market as risk appetites have expanded. The US Infrastructure Index was up 4.4 percent for the week. Driving this increase was energy infrastructure, and the AMLP Alerian MLP Index was up 3.8 percent for this week. The Dow Jones Utilities Index was up 1.7 percent for the week. REITs also performed well, and the Dow Jones US Real Estate Index was up 3.3 percent for the week.

The backdrop of an accomodative Fed, an increased rate of COVID vaccinations, earnings growth being off of cyclically low levels, and hopes for fiscal stimulus have created a consensus Goldilocks scenario for the economy, as well as the stock market broadly. What’s more, cash levels among institutional investors remain high, and money market balances are at historic highs. There is consequently plenty of dry powder waiting on the sidelines, defensively positioned. If the trend continues, these investors will be forced to play catchup as they are left behind by their benchmarks. While there are areas where valuations are extended, there are also many areas where there still remains significant value.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC