Weekly I try and put together a set of salient facts that I feel are important to be considering so as to be as confident as possible that a portfolio is properly allocated for the purposes of the investor. The facts that I feel are relevant this week are broken down into a number of different areas. At different times each will be more important than another, but all of them I believe are somewhat instrumental in the current investment climate.
- Oil & Natural Gas- the world is being affected far more than we are domestically as we are a net exporter of oil.
- Where are our US Equity markets- looking at long-term charts and them zeroing in on the current situation and what does the current environment look like.
- Debt- since after currencies, the debt market is the second biggest financial engine of the world, how is it looking currently? Primarily I am focused on the spread between Hi Yield debt and Hi Quality debt and the current problem of Private Debt Markets.
- The emotional side of the US Equity market- what does this look like and where are we on a typical continuum?
- Cyclical market action- how long since the last pullback / digestion? Does it even really matter “why” or is it really important to remain as objective as possible and focus on historical statistics?
We are in a decline. This is certain. The strange thing is that it is a rotating decline. I say rotating as the entire market (both US and Foreign) are not going down at the same time. According to FundStrat Direct, when focusing on the S&P 500 it is a “rolling bear market.” As you can see below, the FundStrat team has subdivided it into Energy, Financials, MAG 7, and Technology in general.
The key is that we are currently sitting with 68% of the S&P in a correction. Strangely enough, oil is up at $100 a barrel and the Energy / Materials stocks are not skyrocketing like the price of oil. Is this a testament to the negative effect of higher oil prices on the economy? Or is it the cause of the oil spike (Middle East conflict- and fear of contagion) that is causing this?
Now let’s zero in on oil and natural gas. If we look at oil in general surging oil prices are relatively better for the US, exclusive of the inflation that is caused by the higher price of this basic manufacturing and consumption component.
Actually, as seen below, in 2025, the US exported 35% more oil than it imported. This is clearly a drastic change from the early 2000’s and could be a big reason for our internal, economic resiliency.
To give an even more drastic illustration. See below the overall output of both Oil and Natural Gas production. Since the lows in 2010, we have definitely been “Drill baby drilling!”
Since the war in Iran seems to be centered on the Straits of Hormuz, I thought it would be relevant to understand who produces the oil that goes through the Straits and who consumes this oil. Now that Venezuela’s production is aligned with ours, and together we are a huge percentage of overall production, it can be a little more clearly understood the current “Chess Game” that is going on with China, Russia, and most recently, Cuba. Due to the Straits being closed.
What I keep on coming back to is that if this oil issue, along with the war is really a negative to the US economy, it should be reflected in higher inflation due to the price of oil and the immediate need for industrial metals and other intermediary goods. As can be seen below, the war has had little effect. Where great affects have been felt (highlighted in yellow dots) were the Great Financial Crisis and the expected shutdown of everything due to the interest rate spike in 2022 on the tail end of the helicopter money from the Fed post-COVID. In order for this war to really have much of an effect, it will need to be quite prolonged and destructive. At present we really can’t forecast or measure this.
In examining the US equity markets going all the way back to the 1920’s, it can be seen that we have been in a upward channel- overall and we are right now breaking above this channel. The chart below is the most relevant long-term view of the US equity market and represents the bullish channel the S&P 500 has been in going back to the 1920s. The index climbed above the upper green channel line last year and has since remained above it. That effectively “unlocked” more upside potential for stocks that wasn’t there as long as that upper line held as resistance. Now, we ideally want to see the S&P remain above the line since falling beneath it could create a false breakout and open up the potential for a bigger decline. Please take a look at this as it is a clear validation of the sheer strength of long-term investing in US markets. My work is far more granular on a weekly basis as I feel the need to address the “noise” that we are all faced with throughout each and every day.
Now that we have the bird’s eye view of the market going back over a 100 years, here is the “zoomed in” version. I do think the general 6600 area is relatively important as that is where the green line sits. It is also important to respect that the line might have been threatened over the past week for the first time really since November. This is why I put the small yellow highlights at these important points. So far, the line has clearly held. Should we get a subsequent drop beneath it, that won’t immediately mean we need to prepare for even lower prices but instead that a closer examination might be warranted. The longer it remains beneath it, though, and particularly if we get a monthly close beneath it, the more we’ll need to proceed with more caution even in the bigger picture. It hasn’t happened yet, however.
In the past newsletters I have given a lot of attention to Private Debt and specifically Jamie Dimon’s “cockroach” statement. I really find this to be important not due to its overall size relative to size of the market of overall debt, but most specifically the psychology of this debt instrument. The freezing of this market is a disaster as it affects most all alternative investment investors. This is why we have 100% steered clear of these alternatives. I would rather be late and more confident and understanding than early and sorry. Here are the news headlines:
Besides the negative action out of the Private Debt markets, the real way to measure if there is a problem in the debt markets that is stirring and telegraphing much greater negativity in equities is the spread between what is being paid in the Hi Yield Debt market and the Investment Grade and or US Treasury debt market. This is tremendously important as it is a measurement of access to capital for all companies and what this access is costing them. If it is thought that there is heightened risk out there and at the same time a decreasing growth rate in the overall economy, there will be cracks forming in the debt markets. This is because there will be some fears of defaults as business slows. THIS IS NOT HAPPENING! Actually, strangely enough, the spread have actually gotten tighter in the last couple of weeks. This is in the face of the lock-up in Private Debt markets and a war. I find this very important to recognize and I believe is a testament to underlying strength of the US economy in the face of so many things being thrown at it. Here is the picture. I have circled the most recent shrinkage of spread on this graph. Please also see where I have circled the spike- which is what would be expected today with oil spiking and war, at the Tariff period in April of last year. Please take a moment and sort of marinate on this chart. It is truly important:
Now that we have a pretty good understanding of what is roiling the Equity and Debt markets of the world, the question then becomes, “Where are we in this turmoil? Is it about to end? Is it close to the beginning and could it get really ugly?” To answer these questions, I look at two things in order. First, how is the economy doing? Well, at this point, still very good! Unemployment due to AI, DOGE, and Immigration seems to be contained, GDP is still positive, and ISM manufacturing and Global PMIs are all in good shape and signaling underlying vitality. The second one is the shorter-term emotional volatility. This is where there are some pretty violent extremes present. According to Mark Newton of FundStrat:
Furthermore, as shown below in this chart from JP Morgan, the S&P Customer “Put Deltas” have reached very negative levels, showing that many are positioning for an extreme event. To be clear, Puts are insurance policies on declines in individual companies or indexes. As can be seen below, emotions are at an extreme. Investors have more puts out there than ever before in history!
If we take this one step further, and look at a combination of Rally Watch Indicators, it can be seen that we are at an extreme of almost nobody looking for a rally. This tends to happen at turning points in the markets- particularly when the underbelly of the economy is not showing an exogenous shock or there is no evidence of debt stress or economic slowdown. Going back to when this Cyclical Bull Market really took off in late 2022, here is where this measure of rally watching lies:
The final point I wanted to touch on was where we are in the cycle. Now, to be clear, “Cycle Work” tends to be tremendously esoteric in that it is a bit of “Hocus Pocus” if you will. All the same, I believe that attention should be given to most all types of studies if they seem to add value. As can be seen in the SPX Cycle Composite below, the US equity market should hit some kind of an emotional cyclical low sometime in the beginning of this year. This aligns with the history of negative second years of presidential cycles, unmeasurable outcomes of new Fed Chairmen being elected, and unmeasurable outcomes of midterm elections in November of this year. This is a lot!
So, what is an investor to do? Make sure portfolios are balanced as you would like, make sure that exposure is where relative strength appears being treated best, and try and make sure that what is owned is in the way of where the world is going. In these points, history is NO GUIDE. Every time is a bit different. There is plenty of science to what we do, but also a lot of art. It is important to not be extreme, but rather to be well grounded, diversified, and I believe try and stick with the highest quality as quality tends to, like cream, always rise to the top.
With breadth measures depressed and the S&P 500 currently almost 3% beneath its “trading” 20-day moving average, we should be near a point where stocks “should” try and bounce. As I always say, it’s usually when stocks “should” bounce but do not that we really should be most careful. The last picture I want to leave you with is that of past wars, going back to Vietnam. As can be seen, almost every time markets rally coming out of the initial conflict. Notice I said, “almost every time” not “every time.”
- Ken South, Tower 68 Financial Advisors, Newport Beach
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