Market Shift – Rotation Into Value?

Negotiations around a fiscal stimulus package drag on, and COVID cases continue to rise – as expected into winter. The financial markets have been experiencing a great deal of consequent churn, and, under the surface, some sector and style rotation. Big tech, the best game in town, has started to give up leadership. Bubbling under the surface seems a nascent rotation into value. Although the S&P 500 was down 88 basis points, and the Nasdaq 100 closed the week down 1.68 percent, the broader Value Line Index was actually up 26 basis points for the week. The Russell 2000, also a broad measure of stock market performance, was up 1.25 percent for the week. The big question remains – what happens to the markets when the cyclical earnings bounce off of depressed levels (i.e., “easy comparisons” are behind us)? Regardless, it is somewhat refreshing to see the markets move away from the largest S&P names, and perhaps it is an early sign that market leadership is shifting. A few weeks do not a trend make. However, it is notable.

This is evidenced in energy, in particular. While very dependent on a cyclical economic recovery, which may or may not be a dubious assumption, the stocks have performed well in the face of significant demand headwinds. In the Global Natural Resources area, it was really energy that drove the bus in terms of performance this week. The S&P Global Natural Resources Index was up 93 basis points for the week. The S&P Oil and Gas Exploration and Production Index was up 4.1 percent. Coupling hopes of a cyclical economic recovery with supply discipline on the part of OPEC and US shale producers has sparked a rather powerful rally over the last month in oil and related equities. We continue to believe that a bottoming process is occurring. However, it will be very choppy. A significant inventory overhang, in both visible supplies and reserves in the ground, remains.

Other commodities that are more levered to an economic recovery were decidedly mixed. Platinum was off 1.3 percent for the week. Copper was up 47 basis points. Net long positioning on COMEX remains very bullish, and investors have piled into Dr. Copper as another way to play a cyclical recovery, although it is hard to see “value” at these levels. Nickel was off 84 basis points, aluminum was off 1.8 percent, zinc was off 37 basis points, and iron ore was up 3 percent.

Precious metals generally treaded water for the week. Gold was essentially flat. The GDX Gold Mining Index was off 48 basis points, and the GDXJ Junior Gold Mining Index was off 91 basis points. Several producers have given operational updates for the upcoming year, and are generally within expectations. Cost inflation remains muted at this stage of the cycle. Balance sheets remain healthy, free cash flow yields are attractive, and we think there are further dividend increases to come. The risk/reward is positive, although we recognize that investors may continue to rotate out of “defense” in lieu of pursuing opportunities in companies more levered to an economic recovery from very depressed levels. Silver was also flat for the week.

Further evidence that there is a rotation out of “defense” was apparent in real estate. The sell-off was fairly broad across property types rather than limited to those with more acute fundamental problems in the form of vacancies and delinquencies – particularly in lodging and retail. The Dow Jones REIT Index was off 2.2 percent for the week. This makes sense in the context of the sell-off in the bond market, and we are cognizant that this is a significant factor that drives performance in this sector. Yield heavy energy midstream sold off as well, and the Alerian MLP Index was off 71 basis points. Utilities were essentially flat for the week. We think a rotation from this area may present some very interesting opportunities, and we continue to keep sharp pencils.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC