By: Kent Engelke | Capitol Securities
Many times I have commented about the narrowness of the markets citing the WSJ, Barons, etc. All know the statistics. The entire 2018 gain in the S & P 500 is the result of 4 stocks, one of which is up about 48% YTD and is now the third largest company in the S & P 500, representing about 38% of index’s 2018 gain. Another is up about 112% and about 18% of the S & P 500 return.
Yesterday, PIMCO commented about this narrowness. Writing today that it is the most crowded trade in at least a generation, perhaps in history. PIMCO further writes the market is in a more difficult situation than most believe because of this narrowness and there is a distinct probability an event will shatter the illusion of liquidity (and safety) in the markets.
This narrowness is gaining momentum because of market mechanics that focus upon size, speed and cost of execution. It is a massive snowball gaining momentum, completely out of control, inferring perhaps nothing can stop it until it comes to a climatic end.
These remarks are similar to those that have been made by other bulge bracket firms, but what I found interesting is that PIMCO used NFLX as an example.
NFLX is up about 112% YTD, following a 55% gain in 2017 and is the twenty-fifth largest member of the S & P. It is one of the four companies that comprise the S & P’s 2018 YTD gains.
PIMCO writes NFLX is trading at 7x EBITDA (earnings before interest, taxes, depreciation and amortization). It is $6 billion in debt, $5.5 billion of which was raised during the past five years, spending $4 billion of this amount. It is not expected to be “cash flow positive” for at least another five years.
Generically speaking, companies trading with such metrics are viewed as firms in “financial distress” and are possible candidates for restructuring if performas’ are not met.
Many times I have commented the markets are devoid of macroeconomic, geopolitical and security analysis. Approximately 90% of investing decisions are made by using momentum as the primary indicator, defined as algorithmic and passive/indexing strategies.
As PIMCO writes, there is a strong probability that today will end, but the question is when and how much carnage will ensue.
I find that poor performance of “quant funds,” or funds that slice and dice equities based on traits like profitability and price volatility as compared to the rest of the market, are thus experiencing their worst year in eight years. They are vastly underperforming in the markets posting near double digit losses. This trade is popular and is/was viewed as a conservative strategy. As inferred, it is a crowded trade and when trends change, buyers can be sparse.
Pivoting to inflation, the PPI rose by the greatest amount since November 2011, exceeding expectations. The data suggests that inflationary pressures are becoming more embedded at the producer level, but the question at hand is whether or not these increased costs can be passed onto the consumer. If they can’t, margins can suffer. If they can, monetary policy assumptions may be yet again questioned.
Today’s CPI data can offer some insight into this question.
Commenting about yesterday’s market activity, equities declined moderately amid renewed tensions over trade and geopolitics. Oil fell the most in two years even though inventories fell by the greatest amount since September 2016 and overall inventories are at levels last experienced in February 2015. Trade woes were blamed for the selloff in crude.
What will happen today?
Last night the foreign markets were up. London was up 0.79%, Paris was up 0.80% and Frankfurt was up 0.61%. China was up 2.16%, Japan was up 1.17% and Hang Sang was up 0.60%.
The Dow should open moderately higher on a subtle shift in Chinese trade attitude to one of possible compromise. Oil is rebounding as the IEA stated output in OPEC is stretched to the limit and may have difficulty in supplying losses elsewhere in the group. The 10-year is off 4/32 to yield 2.87%.