Expect The Unexpected

by: William Koldus, CFA, CAIA


- Copper has been up for 14 consecutive days.

- The S&P 500 rose on an unexpected Trump victory.

- Gold sold off after the unexpected results of the election, defying market prognosticators.

- Long-term interest rates have had their biggest move since 2009.

- REITs have been down 11 of the last 14 weeks, with industry leaders giving up their 2016 gains.

The good times are free, and no one can take that away. 
- Zac Brown
 
Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. 
- Sir John Templeton
 
Life and investing are long ballgames. 
- Julian Robertson
 
Human emotions, specifically fear and greed, drive the financial markets to extremes more frequently, and more consistently, than statistical models would predict.
 
As expectations solidify around a perceived outcome, a narrative takes hold that dominates the headlines, even though the certainty of this narrative is tenuous, and the ability for humans to alternate between emotional extremes and change narratives is well documented.
 
The U.S. election is a prominent example of market participants putting the cart before the horse. The certainty of Secretary Clinton winning the presidency trumped our own inherent recognition and knowledge that the outcome was less than a foregone conclusión.
 
Another prominent example is the commodity markets, which can go from boom to bust to boom faster than most can imagine. A scant six months ago, metallurgical coal was left for dead, and today, it is hovering around all-time highs, and this move occurred almost entirely before the U.S. election.
 
The writing on the wall was there, and I tried to document it, and capture it with Peabody Energy (OTCPK:BTUUQ), in one of my biggest ongoing investment challenges, after the worst downturn in history, yet nearly everyone became comfortable with the status quo, and shut off their imaginative reasoning.

In summary, investors, speculators, and traders need to be careful what they perceive as certainties, because the status quo and consensus expectations can, and will change.
 
Thesis
 
The consensus expectation for the financial markets is consistently wrong, so investors should embrace the unexpected possibilities.
 
Copper Rises 14 Days In A Row
 
In the wake of the U.S. election, a story that is emerging is the potential for increased infrastructure spending. Industrial metals like zinc, nickel, and copper have put in their best winning streak in years.
 
In fact, copper, has been up 14-days in a row, reversing firmly higher after a long decline.
 
(Source: William Travis Koldus, stockcharts.com)
 
 
This has propelled copper stocks like Freeport-McMoRan (NYSE:FCX), one of the equities profiled in my "Too Cheap To Ignore" series higher.
 
(Source: WTK, stockcharts.com)
 
 
Astute observers will notice that the recent move higher in FCX shares merely continues a historic reversal and rally that began early in 2016, when deflationary expectations were at all-time highs, and fears about the markets and the solvency of commodity producers dominated the talk of market participants.
 
The S&P 500 Rises On A Trump Victory?
 
Most investors predicted that an unexpected Trump victory in the presidential election would tank the stock market, as measured by the SPDR S&P 500 ETF (NYSEARCA:SPY). They were right for a few hours. However, a funny thing happened, in that the U.S. stock market defied the consensus expectation, rallying back from a sharp initial decline, to advance on the day after the election.
(Source: WTK, stockcharts.com)
 
In fairness, I have been bearish on the broader stock market for years, and improbably, against historic valuations, it appears to be rallying in the final innings of the epic, unloved bull market, that has been one of the longest in modern market history.
 
(Source: WTK, stockcharts.com)
 
 
Is the stock market overvalued? The unequivocal answer is yes! Before it ends, however, bull market is likely to confound nearly every bearish investor, like Dr. John Hussman , who I have tremendous respect for and empathize with, even though they may ultimately be right in their analysis.
 
Gold Sells Off On A Trump Victory?
 
Defying consensus expectations again, gold, as measured by the SPDR Gold Shares ETF (NYSEARCA:GLD), and gold stocks, as measured by the VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) sold-off, after initially rocketing higher, in the two days after the election.
 
(Source: WTK, stockcharts.com)
 
 
Despite the recent negative sentiment, the longer-term picture for gold, and precious metal shares, looks brighter, as the five-year chart of the GDX shows.
 
(Source: WTK, stockcharts.com)
 
 
Clearly, a long-term reversal has taken place in 2016. After sentiment is reset, which it is in the process of doing now, in my opinion, precious metals, and precious metals shares may appreciate for a different reason than fear, specifically they may rise due to increased inflationary expectations.
 
Bonds Have Their Biggest Fall Since 2009
 
After oscillating on the edge of one of the biggest bubbles in history for the past several months, the bond market appears to have reversed course, and had definitively turned lower.
 
Long-term treasury bonds had their largest losing day in five-years on Wednesday, and the carnage continued on Thursday. The scope of the decline is evident when looking at the price chart of the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT), which is shown below.
 
(Source: WTK, stockcharts.com)
 
 
Long-term Treasury yields have risen around the world, erasing much of their 2016 gains, as the following charts of the 10-Year Treasury Yields from the U.S., the U.K., German, and Japan show.
 

(Source: WTK, stockcharts.com)
 
 
What happens if yields rise further? How should an investor position his or her portfolio after their clearly has been a changing of the guard in stock market leadership?
 
REITs Have Collapsed
 
One sector that has lost its leadership status due to the change in interest rates is the REIT sector.
 
After enjoying historically high publicity with the new sector designation in the S&P 500 and an incredible run of good performance, higher interest rates have put a monkey wrench into the long REIT thesis, just as investors were getting comfortable with the seeming invincibility of this unique asset class.
 
After being up over 18% for 2016 at the end of July, the Vanguard REIT ETF (NYSEARCA:VNQ) has given up almost all of its year-to-date gains, and is only up 0.6% for the year after its recent string of declines.
 
(Source: WTK, stockcharts.com)
 
 
The largest REIT, Simon Property Group (NYSE:SPG) is down 3.9% for 2016, after being up 19.0%.
 
 
(Source: WTK, stockcharts.com)
 
 
One of the most popular REITs, Realty Income (NYSE:O), which I wrote two bearish articles on during the summer, has stumbled badly with the rise in rates, and is now up only 8.6% for the year, after having been up 42.9% at the end of July.
 
(Source: WTK, stockcharts.com)
 
 
When looking at the charts above, investors should notice that the change in trend started well before the results of the presidential election were known. In this way, the unexpected results were merely the cherry on top of the sundae.
 
The Takeaway - Expect The Unexpected
 
When sentiment reaches extremes, investors, speculators, and traders should look the other direction, as a reversal in sentiment can lead to extreme price changes.
 
How high will the price of copper go? How high will interest rates rise? How far will REITs and other interest rate sensitive sectors drop?
 
These are important questions, and the answers are unknown, though I have some speculative, educated probabilities in mind.
 
What I can tell you, though, from actively trading in the markets for over 20 years, and being a market historian for the entirety of my adult life is this. The consensus expectation is often wrong at key turning points, and trends and reversals in trends can exist for far longer and extend far higher or lower than almost anyone imagines. Thus, investors, speculators, and traders need to keep an open mindset right now, and re-evaluate their positions and their portfolios, in my opinión.

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