February 7, 2016 Strange Relationship

Risk/Reward Vol. 294

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Do U know?
I think U and I got a strange relationship
What's this strange relationship?”---lyrics from “Strange Relationship” sung by Prince

“If you're down and confused
And you don't remember who you're talking to
Concentration slips away”---lyrics from “Love the One You’re With” sung by Crosby Stills and Nash

“Tell me, tell me, tell me lies
Tell me lies
Tell me sweet little lies”---lyrics from “Little Lies” sung by Fleetwood Mac

“Do you know/I think oil and the S&P 500 got a strange relationship/What’s this strange relationship?” Lately, as the price of oil goes, so goes the S&P. At the close on Friday, that correlation is 97% year to date. Huh? OK, maybe there is some relationship between the price of oil and the stock market. Lower oil prices reflect less demand, and lower oil prices mean fewer oil patch jobs. But, logically, any such relationship should be more than offset by the positive impact that cheap fuel has on consumer pocketbooks. Shouldn’t it? Apparently not today. Now add to the mix the relationship between the relative value of the dollar and the price of oil. Look what happened on Wednesday. Influential Fed member Bill Dudley cast shade on the likelihood of a rate hike at next month’s FOMC meeting. On that comment, the dollar fell in relation to other currencies causing the price of oil to rise 8% almost immediately. That news, in turn, caused the Dow Jones Industrial Average to go from a negative 193 points to a positive 183 points in a matter of minutes. YIKES!

Recognizing that a correlation exists explains directionality, but does not address the rapidity of the reaction. Since early January, oil and stocks have traded in lockstep, minute to minute. How can so many market participants react so quickly and so uniformly? On this point, John Boy, aren’t you “down and confused?” Not really, Dear Readers. “Don’t you remember who you’re talking to?” The answer is found in the “concentration” which exists in all markets today. The total market value of the S&P 500 is $18trillion. The total market value of the US bond market is $37trillion. Combined their market value is $55trillion. According to benefits consultant Towers Watson, the top five US fund managers have $14.4 trillion under management (for illustration purposes 14.4trillion/55trillion= 25%). The top dog, BlackRock, manages $4.7trillion alone. In other words, if just a few people atop a few firms sense (create?) a correlation, they can move the needle so as to make any such prophecy self-fulfilling. I don’t believe that a grand conspiracy exists, but the above statistics go a long way in explaining the minute to minute, lockstep correlation that exists today.

Although the previous week’s gains in the indices evaporated , my portfolio (85% in cash plus a few REIT's and a few preferred stock funds) continued to gain ground, albeit modestly. That is because the yield to which REIT's and preferred stocks are correlated (that on the US 10 Year Treasury Bond) continued to move downward, and downward yields equate to increased prices. I added GM and Ford midweek after both dropped dramatically despite record earnings and upbeat guidance. Their 5+% dividends should keep their prices from falling further. I did not buy any oil as that entire sector continues to take a beating. Perhaps deservedly so. Take Conoco. In December, Conoco’s CEO reiterated that the company’s number one priority was maintaining its dividend even at the expense of capital expenditures. So you can imagine the market’s surprise when that same CEO announced this week that Conoco was cutting its dividend by 66%! “Tell me, tell me, tell me lies/Tell me lies/Tell me sweet little lies”---indeed. This is not the first time that a CEO hath protested too much when asked about the sanctity of a dividend, and sadly it won’t be the last.

This market is like a Prince best hits album. If you follow the markets minute by minute, you will go “Delirious.” So “Let’s (not) Go Crazy.” This is not “1999” with its infamous internet bubble. And it’s not 2009 either. That said, no one is profiting enough to buy a “Little Red Corvette.” Just remain calm, don your “Raspberry Beret” and stay out of the “Purple Rain.” Next week, pay attention to Janet Yellen’s Congressional testimony. If she infers that no rate hike will be forthcoming in March, the dollar will drop in value, the price of oil will increase and, as if in lockstep, stocks will rise. If she hawkishly indicates that a rate increase could occur in March, you will "hear what it sounds like when (interest rate) doves cry," and the opposite will occur.