How Windy Is It . . . ? Monday, 8th February 2016 – No.165

How Windy Is It . . . ? Monday, 8th February 2016 – No.165

How windy was it last week?

It was certainly gusty last week and some might say it had been threatening for a while, but the sector rotation had been coming for a while. 

After a couple of warning shots over the past few weeks, last week looked more like the real thing for sector rotation.  The price action in both miners and energy were one of the biggest single day short squeezes we have witnessed since the Global Financial Crisis.  But why did it happen?  To put it simply, in order to maintain short positions* in these names, which is still an incredibly crowded trade in the market, the belief must be that more bad news is on the way.

This looks increasingly less likely and with a rise in oil price, other commodities such as copper and news of the Chinese steel mill closures which in fact is pointing in the opposite direction.  The pain exerted on these short positions is immense and we are seeing shorts closing.  This typically indicates that we are nearer the bottom than consensus may be showing.

This makes life difficult for investment funds in the short-term which outperformed in the main due to energy and resource underweight positions.  If these funds want to buy back some of the underweight to mitigate short-term performance risk, they need to sell something and they can only sell what they own.  This explains one of the more interesting features of last week: what underperformed.  The sectors of food and beverage consumer staples and healthcare all dropped significantly on virtually no company specific news.  If the marginal buyer of the expensive stock turns seller, then who picks up the slack?  The answer last week was no-one, not at the current valuations, which meant a fall of around 4% for the aforementioned sectors. 

This is of course extremely short-term and it does not indicate any sort of trend.  What is interesting though is last year’s winning sectors turning into last week’s losing sectors.  Not something to overly be concerned about in the long-term, but something not to ignore either.

 

*it is not often that ‘Windy’ becomes a film critic, however last month saw the release of ‘The Big Short’  which is based on the 2008 Global Financial Crisis.  It goes along way to explain ‘shorting’ and how the crisis happened.  It may not seem the obvious film to go and see (and at first glance seem a film you would want to avoid), however it has received rave reviews and we would urge you to see it.  It could even be a Valentine’s Day film as it stars Brad Pitt, Ryan Gosling and Christian Bale.

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