Energy Weight In S&P 500 - Lowest Since 1990?

Energy Weight - Stocks Rally After Worst Day Of 2019

Before getting into Energy Weight let's review the markets. Historically, we have seen President Trump pull back on hawkish trade rhetoric when the stock market falls.

Fed has also helped stocks by shifting dovishly after big declines. Nothing of that nature happened on Tuesday, yet stocks still snapped back. S&P 500 was up 1.3%, Nasdaq was up 1.39%, and Russell 2000 was up 0.99%.

VIX was high on Monday and that it moved lower in the next month. That didn’t take long to happen as the VIX fell 17.97% to 20.17. It’s no longer very high. It’s in a reasonable area considering the uncertainty on trade.

Fear Is Still In The Market

Energy Weight - CNN fear and greed index increased 5 points to 27 as it went from extreme fear to just fear. In the latest AAII advisor sentiment poll, the percentage of bulls fell from 57% to 48%.

Percentage of bears was 18%. Following sentiment works best when stocks are rallying. It slowly increases in which case it indicates the market is due for a selloff. It’s tougher to follow when stocks are falling because people quickly panic.

Even if you pay to get survey information early, it’s probably too late. The stock market is a real time measurement of sentiment. CNN index uses market data, so it works in real time.

Energy Weight - Sector Action

Unsurprisingly, every sector was up on Tuesday except one. Energy fell 6 basis points. As you can see from the chart below, the energy sector’s weighting in the S&P 500 is the lowest since at least 1990.

It is way below its long term average of 4.7%. To be fair, the rally in oil prices in the late 2000s doesn’t mean energy stocks should be more valuable now. Fracking has created more supply in the past decade.

Tuesday’s market was an incomplete reversal of Monday’s selloff. It wouldn’t make sense for all the losses to be regained because there’s no new evidence a trade deal is likely to be made soon. It’s my personal belief a détente or real deal will get done within the next few months. Mostly because Trump is up for election, but in terms of actual news, nothing happened.

Best 2 sectors were technology and financials as they rallied 1.61% and 1.51%. Those were the worst 2 sectors on Monday. I wouldn’t buy the financials because the Fed is still expected to cut rates. Only buy the financials if you think rates are headed higher and that the Fed will cut rates less than expected. I’d short treasuries instead of buying financials, but it’s an option.

10-2 Year Curve Comes Closer To An Inversion

Energy Weight - As of Wednesday morning, treasuries are rallying again and the difference between the 10 year yield and the 2 year yield is falling. It is close to its flattest point in the cycle. When the 10 year yield falls below the 2 year yield, there will be a lot of headlines stating how bad this is. It could cause investors to sell risk assets just like the start of the yield curve inversion caused investors to panic in late 2018.

As of Wednesday morning, the 10 year yield was at 1.68% and the 2 year yield was at 1.57%. That’s just an 11 basis point difference. It hit 11 basis points in early December. At this extreme point, a hawkish statement by the Fed simply prevents the market from pricing in more rate cuts rather than actually pricing in less rate cuts.

It seems like almost every day the market expects lower rates than it did the prior day. On Tuesday, the percentage chance of a 50 basis point cut in September actually fell from 29.2% to 23.5%. That’s a minor change compared to the recent action.

Energy Weight - Bullard Not Sold On A 50 Basis Point Cut

Bullard, who is widely considered one of the most dovish members of the Fed, spoke on Tuesday. He stated, it’s “not clear you want to pile on more [easing].” That’s consistent with the midcycle adjustment rhetoric at the Fed meeting last week.

Furthermore, when asked out the possibility of a 50 basis point cut, he stated, “we’re not in that situation... there are a lot of good things going on in economy. We don’t need to be quite as dramatic.” That’s not a surprise because he didn’t favor a 50 basis point cut in July.

That being said, if the Fed is going to keep cutting every meeting anyway, that’s not much of a difference from cutting 50 basis points. A double cut might temporarily shock the market. But it takes a few months for rate cuts to affect the real economy anyway. There's not much of a difference between cutting rates 50 basis points in September and cutting rates once in September and once in December.

Obviously, the trade war is the hottest topic in economics.

Energy Weight - When asked about how it affects monetary policy, he stated, “Recent developments in global trade negotiations suggest that it will be difficult to reach a stable global trade regime over the forecast horizon.” High trade uncertainty is already “judgmentally factored into my monetary policy calculus.”

Bullard doesn’t want the Fed to react to day to day trade actions and rumors, but the Fed is clearly more dovish because of the trade war.

Energy Weight - America Is Almost The Only Positive Rate Economy

Based on global yields, American real yields are too high. Global central banks have been cutting rates for about 2 years, while the Fed just stared doing so.

As you can see from the chart below, America accounts for 88% of all yield paid on global investment grade fixed income despite being just half of the market. That’s because American yields are higher than abroad. I consider this to be a positive for America.

Having near zero percent rates on investment grade debt creates zombie companies which are run poorly. But won’t go bankrupt because of free money. Unfortunately, America might also have negative rates in the next recession.

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2 Comments

  • Les

    August 8, 2019

    If America were to go to negative interest rates, how would that impact equities? Is it true that the last major recessions were lead by the energy sector turning to the downside? President Trump (God bless him) has stated that our Markets are going to go way higher. Is that a lead to progress in trade talks? I know we should trade what we see in the technicals and not what we think. I'm very glad to be a member her at Theo trade, and would like to focus a small account to a trending trade position if possible. At the same time I would like to day trade the SPY.

  • Les

    August 8, 2019

    If America were to go to negative interest rates, how would that impact equities? Is it true that the last major recessions were lead by the energy sector turning to the downside? President Trump (God bless him) has stated that our Markets are going to go way higher. Is that a lead to progress in trade talks?