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These are the charts and themes that tell the story of 2016…
I. The Worst Start in History (January)
The year started off with a bang as the S&P 500 declined 4.9% in its first 4 trading days, the worst start to a year in history. I cautioned at the time: “predicting bad things for the remainder of the year based on the first for trading days, which is our natural human tendency (recency bias), is not an idea rooted in objective analysis. While the first four days will make for an interesting chapter, the full story of 2016 has yet to be written.”
And what a story it would be…
II. “Sell Everything”: The Call Heard Round the World (January)
By January 11, stocks had continued to fall, and RBS had seen enough. They advised: “sell everything except high quality bonds” and “stay short commodities, especially Oil.”
Every major media outlet ran with the call, only adding to investor anxiety. It is their job to entertain; it is your job to ignore.
III. GreedFear is Good (January)
By January 20, we started to see broad signs of capitulation and fear. The number of new 52-week lows on the NYSE hit the highest level since November 2008 (contrary to what most pundits will tell you, this is actually a good thing).
Every global equity index was down year-to-date, below their 200-day moving average, and at least 10% off their 52-week high. So naturally, I was turning bullish as I spoke at a CFA forecast dinner that very night. When stocks go down and fear abounds, I get more positive; it’s a strange reaction, I know.
“Fear is good,” I noted on CNBC later that week, with all due respect to Gordon Gekko of course. Fewer bulls in the AAII sentiment poll than in 2009 (after a 50+% decline)? A very good sign indeed.
Not everyone shared this optimism. The new bond king closed out January with the following warning: “do not buy a junk bond fund. You’re going to end up selling at a loss as they get more and more populated with distressed energy and mining issues.”
If that wasn’t enough, he added the following: “If you’re going to do anything in emerging market equities, my recommendation is to short them. They may fall a further 40%.”
Not to be outdone, Dennis Gartman (the “commodities king”) said Crude Oil wouldn’t “see $44 again” in his lifetime.
So there you have it: more trouble in junk bonds, more trouble in emerging markets, and Crude Oil was never going to rise again. How could that possibly end well?
IV. “The Market is Always Right” (February)
By February 11, the doomsday predictions seemed to be coming true. The S&P 500 was down 10.5% on the year, still the worst start in history (even worse than 2008, many would note).
All hope seemed lost as high yield energy credit spreads hit their widest level in history: a stunning 1984 bps. “The market is always right,” the pundits said, and the market on February 11 was pointing to another financial collapse.
What were Fed Funds Futures projecting at the time? No rate hikes until mid-2018 and a higher probability of a rate cut than hike at the March meeting. Market participants chanted…
“What do we want? Easy money. When do we want it? Now!”
V. Silver Linings Playbook (February)
And so, on February 11, as the S&P 500 was breaking below 1810 (the January low), a “key technical level,” I decided it was time to pen a silver linings playbook of what could go right.
Two snippets from that piece:
“After suffering its worst decline in history, Crude Oil bounces. Calls for $0 Oil are proven wrong.”
“Credit spreads, at their widest levels since October 2011, start to tighten again as they did back then.”
And about that Fed … “you actually should hope they hike rates this year” because that will mean the economy is doing just fine and the stock market is at new all-time highs. No one, of course, wanted to hear any of that at the time. Misery loves company, it is said, and if you weren’t miserable on February 11 you were in a very lonely place indeed.
VI. Bounces Happen (February, March)
And then, a strange thing happened, and for no particularly good reason. Markets bounced; all of them, in unison. Credit, equities, and commodities all pushed higher.
But many experts were skeptical.
The old bond king, Bill Gross, took a moment out of his busy schedule to tell investors to “use the risk rally to de-risk.”
Jim Rogers argued in early March that there was a ”100% probability of a U.S. recession.” How he arrived at those odds was anyone’s guess, but duly noted that we were warned, as we were in 2009, 2010, 20011, 2012, and 2013…
By March 7, Crude Oil had turned positive on the year after being down over 30% on February 11. “Too much, too fast” the pundits said in unison.
By March 17, the S&P 500 had turned positive YTD. “Dead cat bounce” said the armchair contrarians. They would say the same many more times throughout the remainder of 2016.
The rally would continue throughout March and early April to many screams of “overbought” and “due for a pullback.” As I noted at the time, though, “when the market has been this extremely overbought in the past we’ve actually seen above-average returns going forward.”
It is one of the great paradoxes in markets that both extreme oversold and extreme overbought conditions can be followed by strong returns. Extreme strength begets strength (momentum) while extreme weakness does the same (mean reversion/value). We saw both in 2016.
On April 19, the S&P 500 would hit a new all-time high (total return). Only two months prior it seemed as if the world was ending. That is the nature of markets.
VIII. Records Are Made to Be Broken (April)
In April we said goodbye to the longest downtrend in history for Crude Oil (427 trading days) as it crossed back above its 200-day moving average for the first time since July 2014.
The end of long downtrends in the past had been followed by further gains on average, and we would see that once more for the remainder of the year.
Crude would end April up over 77% from its February low, one of the largest short-term rallies in history (only the spike in 1990 was larger). Yes, it was back above $44, and Dennis Gartman was alive and well.
IX. The High Yield V (June)
In June, U.S. High Yield bonds hit a new all-time high (total return), a stunning reversal from earlier in the year. As we learned in 2011 and again in 2016, every correction in credit does portend “another 2008.” Sometimes a correction is just a correction.
X. Fat Tail Friday aka Brexit (June)
On June 24, following the Brexit vote, we learned once again that the financial world we operate in is not normally distributed but instead fat-tailed.
We saw a move in the British pound (-8%) that should never have happened in the history of the universe. But it did, and given enough time, it will happen again.
XI. There Is No Impossible in Markets (July)
In early July, it became clear that Brexit was a non-event in financial markets as most asset classes had quickly recovered their losses. Most hilariously, the FTSE 100 Index was up 7.9% on the year, the top performing equity market in Europe.
The biggest story in markets in July was not Brexit but the all-time lows in yields around the world. Eight countries had negative 8-year yields and Switzerland, Japan, and Germany had negative 15-year yields.
In perhaps the most insane development in the history of markets, investors were accepting negative yields in Switzerland for the privilege of owning 50-year bonds.
Meanwhile, U.S. 10-Year and 30-Year yields would hit new all-time lows on July 5th. The all-time highs from back in 1981 (at over 15%) seemed like an alternate universe.
What were many predicting at the time? Even lower yields to come. Scott Minerd, CIO of Guggenheim, saw 10-year yields “plunging to 1% by the end of the year” and a “target bottom for the 10-Year of 28 basis points.”
On July 8, the 30-year yield hit an all-time low while the S&P 500 hit an all-time high. This was an unusual development to say the least. Investors were behaving in a risk-on and risk-off fashion at the very same time.
Something was wrong with this picture, and given the rise in inflation expectations (deflation is a myth in the U.S.), my best guess was that it was the bond market. The “smart money” bond investors had overstayed their welcome, I argued, and yields were likely to rise with the yield curve steepening. It took a few months for this to occur (= I was the one who was wrong in the short-term), but the fundamentals were in my favor. There was no deflation in the U.S. and inflation expectations were actually moving up, not down.
My view: U.S. yields were trading lower in sympathy with the maddening negative yield policies in Europe and Japan, not because of slower U.S. growth/inflation. It was only a matter of time before yields converged with fundamentals and that meant a bias towards higher yields.
XII. Manias, Panics, and All-Time Highs (November)
In the week prior to the presidential election, the S&P 500 completed its 3rd correction of the year (21st since March 2009), a modest 5% pullback from its all-time high in August.
Fear was rising and with the election of Donald Trump, panic set in. Few saw Mr. Trump being elected (the NY Times had an 85% chance of Hillary winning, Nate Silver of FiveThirtyEight said “there’s a wide range of outcomes, and most of them come up Clinton”) and anyone who did saw markets crashing as a result (“if Clinton wins, it should be up around 3 percent, and if Trump wins it should be down 7%.”)
And crash they did, for a few hours, with S&P futures going limit down on election night. Stock markets around the world traded lower, as did the U.S. Dollar and Crude Oil. The flight to safety trade was on with Gold up more than 4% and Treasury yields plummeting.
The advice from the experts that morning:
“If you didn’t get to the sidelines before the vote, get to it now. I don’t think we’re going to get a post-Brexit bounce. I think this is something far more serious and far more onerous.” – Dennis Gartman
What happened next?
By the open the next morning, the S&P 500 had recovered all of its overnight losses.
By the end of the next trading day (November 9), everything had reversed course from the initial post-election reaction: stocks rallied, Gold was lower, bond yields moved higher, and the U.S. Dollar Index surged.
The Dow hit a new all-time high that very day.
In weeks to follow, we would witness one of the most ferocious short-term rallies in the history of markets, with Financials (banks in particular), Industrials and Small Caps leading the charge higher.
The Russell 2000 would finish election week up over 10% and unlike the other largest weekly gains in the table below, it was not coming out of a deep correction but sitting at new all-time highs.
Small Caps would end up rallying 15 days in a row, the 2nd longest streak in history.
Bank stocks would surge higher while large Tech stocks fell, adding insult to injury to the many long/short funds positioned in the exact opposite direction.
By mid December, it was clear that the opposite of everything the gurus predicted was occurring…
Dollar up, gold down, and…
Yields surging higher with the yield curve steepening.
As the Fed hiked rates in December for the second time in as many years (and only the second time in the last 10 years), U.S. yields across the curve were hitting multi-year highs.
XIV. Chart of the Year
What was the chart of the year in my view? For me, this was an easy one. There was nothing more incredible than the reversal in high yield energy.
As I wrote back on February 11, channeling my inner Buffett: “if you wait for the robins, spring will be over.”
By year-end, spring was over as distressed high yield bonds (filled with energy companies) had rallied 79% from their February 11 lows.
XV. Wrapping Up: 1991-99 Redux?
And so we close out 2016 with the 8th consecutive positive year for the S&P 500, Dow and Nasdaq 100.
In the S&P 500, only 1991-1999 saw a longer streak of gains at 9. The streak of 8 ties the run from 1982-89 for second place.
Those betting on another 2008 “black swan” suffered yet again, with the long volatility ETF (VXX) down 68%.
It seemed impossible after the first week of January, but 2016 ended up being a pretty good year for markets. So goes January, so goes nothing.
9 out of 10 sectors finished up with Energy, Financials and Industrials leading the charge.
Stocks were not the only winners in 2016. Commodities (CRB Index) would have their first positive year since 2010.
Gold Miners (GDX) also had their first positive year since 2010.
Not to be outdone, U.S. home prices hit new all-time highs, surpassing the prior highs from 10 years ago (2006). Many had thought it would take decades for prices to recover from that epic collapse. The U.S., though it seems, is not Japan.
The rise in home prices comes at a time when mortgage rates are hitting 32-month highs, spiking higher in the past 2 months. Will this be an issue in 2017? I don’t know but it’s something to think about.
In the central bank world, the U.S. remains the only developed country whose last move was a hike. Both the ECB and BOJ cut interest rates in 2016 while the Fed hiked for a second time.
This divergence in central bank policy has lead to the largest differential in U.S./German rates in history and the Dollar Index at its highest level since 2002.
Meanwhile, the U.S. economy continues to chug along, with the longest streak of positive payroll growth in history at 74 months.
The slowest post-war expansion (2.2% real GDP) is now the 4th longest in history, and if it continues through the end of 2017 will be the 3rd longest.
Could the S&P 500 break the 1991-99 record and go up for 10 straight years?
Could the U.S. expansion break the 1991-01 record and go on for 11 years?
Yes and yes for there is no impossible in markets. Just because it hasn’t happened before doesn’t mean it can’t happen in the future. We learned that many times in 2016.
We also learned that “selling everything” in the hopes of timing the next “cataclysm” can be a difficult game to play.
XVI. Happy New Year
These were the charts and themes that told the story of 2016. As always, the narratives followed price. We had two completely different narratives in 2016: from the depths of despair after the worst start to a year in history in February to the euphoria of all-time highs in December (S&P 500, Dow, Nasdaq, Russell 2000, and Mid Cap 400 all hitting all-time highs together, first time since December 1999).
As prices change in 2017, the narratives will change as well.
Where will the S&P 500 end 2017? Where is Crude headed? Is Gold a good investment here? How many times will the Fed hike rates?
I don’t know the answer to any of these questions.
I actually did a presentation this year on the value of admitting to yourself and others that you can’t predict the future. Take the evidence as it comes, be forever humble and thankful, and leave the predictions to those whose job it is to entertain. That’s the best you can do in this business.
In 2017, I predict one thing and one thing only: you will see many more surprises. That is the nature of markets.
Thank you for your readership this year. I hope in some small way you found the information in this blog useful to your journey as an investor.
Wishing you a happy, healthy and prosperous New Year.
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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