It has been a week of moving pieces and mixed signals for equity and commodity markets, headlined by a significant downturn in commodities and significant rotation between equity market sectors. Investors main focus has remained on the future of monetary policy and the prospects for a global reopening recovery this year. News flow related to the COVID crisis took a step backward this week with case counts starting to climb back up a bit in some countries, Germany announcing and then partly backing away from new lockdowns, and questions continuing to swirl around AstraZeneca’s vaccine following the release of new clinical trial results. Commodity traders appear to have woken up this week to the notion that the road to recovery could be bumpier than previously thought and appear to have scaled back their resource demand expectations sending Crude Oil, Coffee, Cotton and Wheat sharply downward. Falling commodity prices easing inflation expectations and the potential for a slower reopening recovery took the wind out of the traded interest rate rebound with the US 10-year treasury note yield dropping back closer to 1.60% from a recent peak near 1.75%. Still, the easy money party appears to be in its later stages with the Bank of Canada hinting at plans to start scaling back its asset purchase program as the economy improves, and the Fed allowing an emergency liquidity program for banks to expire at the end of this month. These developments appear to have sparked significant shifts in sentiment between equity market sectors. Falling commodity prices have dragged on the Energy and Materials sectors. There appears to be some rotation back into technology and internet related groups on the prospects of a slower reopening, with reopening sensitive groups such as retailers backsliding. The coming week brings an end to the month and the quarter. It’s pretty light for scheduled news so we may see portfolio rebalancing, interest rates and COVID related news dominate until the turn of the month brings the usual PMI and employment survey data. In this issue of Equity Leaders Weekly, we look at the relationship between small cap and large cap stocks as an indicator of market sentiment, and at recent swings in the price of crude oil as a proxy for commodities and their implications for interest rates and equity markets.
The relationship between small cap stocks, as represented here by the Russell 2000 Index (RLS.I) and large cap stocks, as represented here by the S&P 100 Index, can give investors insight into investor attitudes toward growth and risk at different points in time. Through 2018 and 2019, RLS.I underperformed OEX.I, culminating in a total washout and selling climax in the early 2020 stock market crash. Following the March 2020 bottom, small caps and large caps then spent several months in balance with each other. In November after the US election, small caps gained the upper hand and staged a strong recovery relative to large caps which ran through to the start of this month. In recent weeks, the trend in the ratio between RLS.I and OEX.I has moved back into balance having returned to the range which prevailed in late 2018 and early 2019. This shift back to a sideways trend for this small cap – large cap ratio may be a sign of a lager shift in trend. The last year or so has been dominated by large crashes and large recoveries. It now appears that markets may be settling into sideways consolidation ranges that could persist for several months while investors digest the big moves of the last year.A period of sideways consolidation lasting 9-12 months is not unusual at this point in the cycle, last seen in and around 1994-95, 2005-06, and 2011-12. Following an initial liquidity fuelled rally up off a bottom, as economies get back up on their feet, the need for easy money diminishes reducing the easy money tailwind and limiting short-term upside for stocks. On the other hand, the improving business environment and a recovery in corporate earnings generally provides support for share prices, limiting downside. The tug of war between the two pushes markets into a sideways range that can last for a while until expectations and valuations are recalibrated.
The price of crude oil has been on a big roller coaster ride, crashing a year ago and then recovering all of the ground it lost, finally recently returning to where it started. Following the 2020 plunge, the Crude Oil Continuous Contract (CL.F), staged an initial rebound consisting of three high pole advances, followed by several months of consolidation between $36.00 and $44.00. Back in November, CL.F broke out of this channel to the upside and now after another large advance of three high poles, the oil price appears to be settling into a higher consolidation range. A Double Bottom breakdown snapped the recent upward trend of advances. Initial support has emerged near $57.30, followed by $55.05 where a horizontal count and previous column lows converge. Initial resistance appears at recent column highs near $63.90 (which was also the early 2020 peak), and $66.50. While the close relationship between energy commodity prices and energy stocks is well known to investors, the recent shift to a sideways trend in oil and other commodities may have wider implications for equity, fixed income and currency markets. Recent gains by crude oil and several other commodities in the energy, livestock, grains, metals and softs groups had started to raise concerns that inflation pressures could increase which put upward pressure on the US 10-year treasury note yield, downward pressure on bonds, and increased concerns that central banks may have to cut back on easy money stimulus and sparked a recent correction across equity markets. With some commodities turning downward recently, such as wheat and coffee, and oil now starting to trend sideways, speculation on rising inflation may ease which could take some of the pressure off of interest rates, bond prices and equity markets.
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