Wennco Market Views: February 2019 Update

Updated: Jun 8, 2019

February Recap & Looking Forward:

While February’s gain of 3.21% in the S&P 500 Total Return Index was a fraction of January’s outsized 8.01% return, it was a slow and steady grind higher. February felt very 2017’esque. Equities were bid, volatility was crushed, and volume was exceptionally muted. Since the 12/24/18 bottom, and through 2/28/19, the S&P 500 Total Return Index annualized gains of 160% and 198% for the Nasdaq (these COMPS are displayed at the end of this note). It’s been a high velocity move and then some. While this continued rally has come on the heels of a massively oversold first 3.5 weeks of December, and a brutal overall fourth quarter, the V-shaped recovery since late-December has reinforced that equity markets remain ‘all-in or all-out.’ What’s interesting is that much of the released economic data – not just in the U.S. – was nothing short of awful during this same time period. In the U.S., retail sales, housing starts and Philly Fed (see below) are just a few datapoints that printed big misses. Growth is slowing in any way that one can possibly slice it, and yet the market is clear that it doesn’t care. Bad data = continued dovishness. It makes sense, but at what point does the weakening global economy begin adversely effecting equity prices? It’s impossible to know - but equities represent ownership in corporations, and the growth trajectory of corporations’ earnings are currently slowing down, as is much of the economic data from developed markets. It will eventually matter. Away from the U.S., China is especially worrisome. The amount of debt in China is dangerously high. Will their recent stimulus have any positive effect? It’s hard to tell anymore. Through February, China’s Hang Seng Index has registered roughly the same YTD returns as the S&P 500 TR (these COMPS are displayed at the end of this note).


Philadelphia Fed Business Outlook Survey

Source: Bloomberg


So what’s driving this move higher? Likely several things: Powell’s dovish reversal last month is likely still fresh in investor minds, China trade deal “talks”, short covering from CTAs and other systematic and risk parity strategies, and corporate buybacks are the main reasons (in my opinion).


From a technical stance, the market reclaimed its 200-day moving average in February, and has now arrived at the important 2800 level. Markets have muscle memory, and the 2800-2816 range is one of supreme interest for both bulls and bears. Both sides have made it clear that this is a line in the sand worth fighting for. 2800 also happens to be – give or take a few handles – where both February 2018 and February 2019 ended (with an incredible amount of price movement in between).


The Importance of 2800:

Source: Bloomberg


The market may look for the next catalyst to trade above this range. Continued dovish rhetoric and/or further progress on China trade talks would probably do the trick (although once an actual trade deal with China is achieved, I expect a “sell the news” event, so further “progress” towards reaching a deal without actually reaching a deal is what the market seems to be happy bidding up).


Here are the updated key drivers that we see as most important in this market (in no particular order as they are all significant):


U.S. - China Trade Talks: The U.S. increase in tariffs scheduled for March 1 were delayed due to progress being made on both sides. There will likely be a lot of trade talk rhetoric in March.

Oil is Holding Steady over $50/bl: $50 remains a key level for WTI Crude to hold for all markets, especially high yield.

Earnings and Guidance: Fourth quarter earnings are now more than 90% done. On balance, reported revenue and earnings haven’t been impressive (with a few outliers), with guidance notably weak.

Interest rates and the Fed: The Fed refused to end the current cycle in 2016 and seems adamant on trying to avoid it again now. The Powell put is newly formed – but its strength and reliability is TBD. After all, he went from hawkish to dovish on a dime. The idea of Powell pivoting back to a hawkish stance - if the data picks up - isn’t a stretch.

Debt: Debt quality is deteriorating at the same time debt levels are very elevated. While there has been some deleveraging in households and the much of the banking sector since 2008, both corporate debt – away from financials - and debt to GDP are at nosebleed levels that can add fuel during the next bear market.


Wennco Downshift ETF Update:

Since inception (7/1/18), Downshift ETF strategy is -0.94% (net of Wennco LLC fees) vs. 3.84% for the S&P 500 Total Return Index through 2/28/19. There has been some relative underperformance from the embedded negative carry in owning truly uncorrelated investments thus far in 2019. Similar to an active stock picker viewing market drawdowns as opportunistic environments to buy names on their wish lists, we view months like January and February as favorable environments to add additional exposure to long-dated portfolio insurance, which we did. When tail-risk is priced as low as it is today, we add. We also increased exposure to Utilities and MLP’s, and decreased exposure to Consumer Staples.


December reminded investors that equity markets may not be as safe today as they were in previous years. As equities get more expensive, the volatility on the downside can increase, which happened in 2018 more than once - but most swiftly in December. This doesn’t mean that the next December is lurking below the surface; but hedged equity managers need to be positioned as if it could happen again, anytime.


Why Downshift? Owning uncorrelated return streams is important to preserving wealth, and especially makes sense in late in market cycles (like where we are today). Bonds have become less uncorrelated to equities, and investors need more reliable sources of protection in risk-off markets. Our strategy has two parts which are negatively correlated: long-dated and actively managed S&P 500 put options and actively managed covered calls. Owning both market beta (direct correlation to the S&P), along with uncorrelated return sources, is a prudent way to grow assets over time. Downshift ETF seeks to minimize drawdowns and maximize compounding returns over the long term.

January’s note included monthly charts of the sector ETFs – this month is focused on weekly charts. All-time-highs and the recent lows that were put in during December 2018 are marked in yellow.


Sector ETFs


XLK: Technology (weekly chart)

Source: Bloomberg


XLV: Healthcare (weekly chart)

Source: Bloomberg


XLY: Consumer Discretionary (weekly chart)

Source: Bloomberg


XLI: Industrials (weekly chart)

Source: Bloomberg


XLF: Financials (weekly chart)

Source: Bloomberg


XLP: Consumer Staples (weekly chart)

Source: Bloomberg


XLE: Energy (weekly chart)

Source: Bloomberg


VOX: Communication Services (weekly chart)

Source: Bloomberg


XLU: Utilities (weekly chart)

Source: Bloomberg


KRE: Regional Banks (weekly chart)

Source: Bloomberg


IYM: Materials (weekly chart)

Source: Bloomberg


AMLP: MLP (weekly chart)

Source: Bloomberg


VNQ: Real Estate (weekly chart)

Source: Bloomberg


S&P 500 & Nasdaq Index COMPS & Annualized Performance (12/24/18 – 02/28/19)

Source: Bloomberg


S&P 500 & Hang Seng Index COMPS (12/31/18 – 02/28/19)

Source: Bloomberg


I hope everyone has a great March. Stay nimble out there.


Best,

Chris


Chris Wenner

CIO & Head Trader

Wennco Downshift Strategies


750 Hammond Drive, Building 5

Atlanta, GA 30328

678-257-2726 (o)

203-984-4287 (m)


Chris@wennco.com

Cwenner5@bloomberg.net

http://wennco.com






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Wennco LLC is an SEC registered investment advisor located in Atlanta, Georgia. Wennco LLC provides asset management services utilizing the Wennco Downshift Strategies and Customized Option Overlay Solutions.