Volatility Ahead (Embrace It!)
- One week from tomorrow: S&P 500 makeover
- “Like walking on the moon”: Wall Street edgy about the shakeup
- Has China run out of tariff options? No, says Rickards
- The tax cut that almost never happened
- “You’re better than this,” a reader chides
It’s T-minus eight days until the big S&P 500 makeover… and a few financial professionals are getting itchy.
We told you last week what’s shaking: The keepers of the S&P 500 index are rejiggering the index’s 11 industry sectors. Facebook and Google parent Alphabet will exit the “information technology” sector and join a revamped “communication services” sector that replaces the present “telecommunications” sector dominated by AT&T and Verizon.
Result: “Mutual funds and ETFs that track indexes will need to rebalance their holdings,” said Alan Knuckman, our eyes and ears in the Chicago options trading pits.
In other words, a ton of buying and selling. “We’ll certainly see some volatility,” Alan promised.
This morning, the Financial Times is finally playing catch-up: “In the short term some are expecting volatility as portfolios are rebalanced.”
From our lips to the mainstream’s ears…
“Understanding the amount of rebalancing to take place is a bit like walking on the moon,” Matthew Bartolini from State Street Global Advisors tells the FT.
State Street is the company behind the enormously popular SPDR family of ETFs. State Street’s Technology Select Sector SPDR, ticker symbol XLK, has $23 billion in assets. The fund will have to dump FB and GOOG, which together make up 15.7% of XLK’s holdings.
BlackRock’s iShares funds, along with Vanguard and all the other ETF families, are in the same boat.
Here are the companies in play… the sectors they’re in now… and the sectors they’re moving to:
A reminder about the rationale behind the move: These days, Facebook and Google are more “content providers” than they are technology companies like Apple and Microsoft. Thus, it makes sense to lump them in with the big media companies and the traditional telecoms.
That’s the official explanation anyway. An alternative explanation is that the current technology sector has just gotten too darn big relative to the other 10 sectors; in the existing configuration it makes up 26% of the S&P 500 — bigger than the six smallest sectors combined.
Key point: S&P 500 sectors have shifted before, but the buying and selling in advance of the changeover a week from tomorrow will be on an unprecedented scale.
“You can do all of the prep, planning, simulation and analysis but you won’t know the exact experience until you are there,” State Street’s Bartolini tells the Financial Times.
And that’s just what financial pros are willing to say to reporters. In private, they have still another concern.
Back to our Alan Knuckman, who picked up some industry gossip from a friend who works at one of the top 10 money management firms in the country.
“Many institutional portfolio managers,” Alan explains, “have been overweight tech and underweight utilities for quite some time.
“This means they have allocated more funds to hot tech plays such as Facebook (FB) and Alphabet (GOOG), but have less invested in utilities such as NextEra Energy (NEE) or NiSource (NI) when compared with the target benchmark they are measured against.”
No doubt that’s resulted in these managers delivering major outperformance in recent years. “But,” says Alan, “it also requires legal clearance from the clients themselves when portfolio managers stray too far from benchmark sector weights.
“Now that the communications sector is about to go live, this requires client investment management agreements (IMAs) to be re-approved — one client at a time.
“Worst of all, if they aren’t done by the time the new sector goes live, portfolio managers may not be able to trade certain securities until their clients approve,” says Alan — “significantly slowing the investment process.”
Truly, the market is entering uncharted territory in advance of this sector shift, set for a week from tomorrow. Volatility will abound before everything shakes out and Wall Street settles in to the “new normal.”
But volatility always serves up opportunity… and Alan’s colleague Zach Scheidt is anticipating what he calls an “extreme income event.” It’s a one-time opportunity to pocket hundreds or even thousands of dollars in advance of the switchover. Stick with The 5 in the coming days for more details…
The Dow industrials are now only 200 points from equaling all-time high eight months ago.
The Big Board has eclipsed 26,400 as we write — adding 156 points to the 185 it gained yesterday. For whatever it’s worth, the mainstream explanation for the jump is that the latest trade war tit-for-tat between Washington and Beijing isn’t as bad as expected. (More about that below.)
Alan Knuckman, who you heard from earlier, points out only 17 of the Dow’s 30 component companies are in the green this year. To his mind, “That leaves a lot more upside on the table for the world’s oldest, most recognized market measure.”
The S&P 500 is also in the green, but the Nasdaq is down about a third of a percent. Gold is holding the line on $1,200, while crude has crossed back above $70.
The major economic number of the day is housing starts, which delivered a big upside surprise. But permits, which are a better indicator of future activity, delivered a big downside surprise. Buyers aren’t stepping up, and even if they were, builders face high costs for materials and a shortage of available workers.
“China’s problem is that it will soon run out of U.S. imports to tariff,” says Jim Rickards.
As noted here yesterday, Washington is upping the ante in the trade wars — imposing tariffs on $200 billion of Chinese imports effective Monday. Beijing for its part responded with tariffs on… $60 billion of imports from the United States.
Earlier in the year, China laid tariffs on $50 billion of U.S. goods. With the new tariffs, Beijing is now imposing a levy on basically all its U.S. imports; it’s maxed out. Washington, on the other hand, has the option of imposing tariffs on another $250 billion of Chinese imports.
“If China is running out of scope on tariffs of U.S. goods,” says Jim, “China can turn to extreme currency devaluation as another way to retaliate. China has already allowed the yuan to devalue against the U.S. dollar almost 10% since June.”
In practical terms, that means U.S. exports to China are 10% more expensive than they were three months ago. Just as good as a 10% tariff from Beijing’s standpoint. By the same token, Chinese exports are cheaper for Americans — helping offset the effects of U.S. tariffs.
For his part, Chinese Premier Li Keqiang is pledging Beijing won’t “actively” weaken the yuan to help fight the trade war.
The World Economic Forum — the global elite gathering every January in Davos, Switzerland — is hosting its first “summer” session this week in Tianjin, China. Li said what the assembled crowd wanted to hear, promising to uphold “multilateralism and free trade.”
But more to our point today, he said, “Persistent depreciation of the [yuan] will only do more harm than good to our country. China will never go down the path of stimulating exports by devaluating its currency.”
We know this much for sure: On Oct. 15, the U.S. Treasury issues its twice-a-year report called Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States. That’s the report where the White House gets a chance to formally label other countries as “currency manipulators.”
Trump and his predecessors have long toyed with the idea of slapping that label on China. But they’ve never pulled the trigger. Jim thinks there’s a high likelihood Trump will do so this time.
That could set off a bout of volatility in the U.S. stock market a lot more severe than anything coming from the S&P sector reshuffle next week…
If we’re to believe Donald Trump’s former top economic adviser, tax cuts for individuals might never have made it into the new tax law. Indeed, the top rate might have jumped.
“Goldman” Gary Cohn — a nickname we gave him because that’s where he worked before going to the White House — spoke to a crowd in New York on Monday. He said it was his opinion that individual tax rates should have been left alone. And for a while, Cohn says Trump felt likewise.
“I would have rather have just cut corporate taxes, not touch personal taxes at all, and by the way the president was there too, the president would’ve just done corporate taxes and not personal taxes,” said Cohn, according to a Business Insider account.
“In fact he was willing to raise the high end of personal taxes, there were times he was talking about 44.6% or 44.9% on the personal side.” Thus Cohn confirmed a nugget from the new Bob Woodward book, Fear.
In the end, Trump had to relent because too many small businesses are taxed as pass-through entities, their owners paying individual tax rates. The “optics” of cutting taxes for corporate giants and not small businesses would have been atrocious…
[As long as Woodward’s name came up: Did anyone else catch his remarks to the radio host Hugh Hewitt? He said he couldn’t come up with any evidence of White House “collusion” with the Russian government.
Hewitt: Did you, Bob Woodward, hear anything in your research in your interviews that sounded like espionage or collusion?
Woodward: I did not, and of course, I looked for it, looked for it hard.
Just to be sure, Hewitt tried again at the end of the interview, according to a story at RealClearPolitics…
Hewitt: Very last question, Bob Woodward, I just want to confirm, at the end of two years of writing this book, this intensive effort, you saw no effort — you, personally — had no evidence of collusion or espionage by the president presented to you?
Woodward: That is correct.
Funny how the crowd that eats up Woodward’s books isn’t saying a peep about this…]
To the mailbag, where a reader wishes to weigh in on the Unified Trump Theory we posited a couple of weeks ago.
“I believe that you’re a good guy and obviously very smart.”
[Of course we see the “but” coming from a mile away…]
“But I also think you’ve been working for the Bonners for too long. Not good for the soul. You’re better than this. Or maybe you’re not and when it comes to you my good-character detector is malfunctioning. I’m still going to continue to read you. I’m just going to close my eyes when I happen upon what I suspect is the Bonner-inspired political stuff you write.
“I read on the internet that members of the Deep State have monthly meetings in the basement of the pizza parlor out of which Hillary ran her child sex trafficking ring. Have you heard the rumor that Deep State members practice Masonic-like rituals and have a secret handshake that includes a one-finger salute? Do you think that could be true?”
The 5: “Bonner-inspired political stuff”?
See, here’s the problem. A few years ago, before anyone imagined Trump would enter presidential politics, I made a not-altogether facetious remark during the mailbag segment one day. I said I was neither a “truther” nor a “birther”… but to the extent such folks help discredit Bush or Obama or whatever regime is in power at the moment, I thought they served a worthwhile civic function.
Now I have to eat those words because there’s a massive number of Establishment types who believe the most absurd things about Trump and Russia — not caring whether there’s supporting evidence and oblivious to the potentially world-ending consequences of ramping up tensions with the only other nuclear-armed superpower.
As Daniel Ellsberg writes in his new book The Doomsday Machine — surely a more important volume than anything Woodward has cranked out in the last quarter-century — “These two systems still risk doomsday: Both are still on hair-trigger alert that makes their joint existence unstable. They are susceptible to being triggered on a false alarm, a terrorist action, unauthorized launch or a desperate decision to escalate. They would kill billions of humans, perhaps ending complex life on Earth.”
From where I sit, and I said this during the campaign two years ago, U.S.-Russia relations are the paramount issue: The markets and the economy become rather secondary matters if the Earth is pockmarked with smoldering radioactive craters.
The 5 Min. Forecast
P.S. Oh, I didn’t forget the reader’s inquiry: I wrote off the whole silly QAnon thing months ago.