The price of West Texas Intermediate crude oil jumped above $40 last week for the first time this year. Since bottoming in mid-February, crude is up 58% trough to peak.
The initial catalyst for the moonshot was the prospect that Iran would join the Saudis and Russians in a production freeze.
Yet the advance really caught fire not from any fundamental change in supply or demand, but from the most elemental reason of all: A colossal squeeze as speculative shorts were forced to liquidate positions in the most gruesome manner.
Energy complex expert Steve Schork reports that since mid-February, speculative longs are up just 3%, or 9,173 contracts, while speculative shorts have been slashed by 45%, or 139,394 contracts. In return, he observes, Wall Street’s “bullish” position has jumped by 429% to its longest net position, 183,238 contracts, since November of last year.
Schork goes on to note that the advance in prices should not be taken to mean that crude is incrementally more in demand in the world, or that supply has dwindled. He reports that over the last three weeks — as spot WTI for April delivery has rallied 35% from a low point of $30.56 to a high of $41.20 — that for every one contract that speculators purchased, they liquidated nine short contracts.
Meanwhile, throughout the rally, shares outstanding in the largest oil ETF have actually been falling, down 14%.
So the question, he concludes, is not how bullish is Wall Street on oil — but how weak are the Street’s remaining bears?
Hedge funds have been playing oil for the past two years with the same ardor they used to reserve for tech stocks. And as you can probably guess, it’s not going too well.
TIS Group reports that in 2015, more hedge funds liquidated than were formed, 979 vs. 968. This is the first time since 2011 that the U.S. market has had fewer hedge funds operating than the year before. In terms of gross numbers, there were 8,454 funds at year-end, down 112 funds from the prior year. As a group, HFs managed $2.9 trillion, so their actions matter.
Industry data shows that the average fund was -2.63% through March 16, vs. a 0.8% loss for the S&P 500. This is not the kind of performance that makes an asset class either un-investable or irrelevant, TIS Group notes, but that sort of massive short squeeze in oil smacks of forced liquidation. This is how one fund’s problem can become a problem for everyone.
TIS Group argues that this is also how seemingly crazy overshoots to value occur in markets. We will probably see more, not less, of this as the quarterly window for fund redemptions closes.
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SMALL SHOCKER
At the start of this year, small-cap stocks were suffering mightily in comparison with their larger brothers and sisters. Then when the rebound started in February, the smalls got revenge by shooting well ahead of the bigs.
But in recent days, smalls have been in retreat again. Tuesday, March 15, was a perfect example, as the Dow Jones Industrials were up a fraction while the Russell 2000 sank 1.4%.
Combining the two periods of under- and over-performance and small-caps come out well behind. Through the Friday close, the S&P 500 is up 0.3% for the year, while the Russell 2000 is down 2.7%.
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According to analysts at Bespoke Investment Group, the Tuesday session marked the 50th day of trading in 2016 and so far the Russell’s daily return only outperformed the S&P 500 on 19 of them. That’s the lowest reading through the first 50 trading days of a calendar year since at least 1979. The only one close was 1997.
So where are we going with this? Well, now here is a surprise.
The Bespoke table below shows the 10 prior years since 1979 where the Russell started off the year under-performing the S&P 500 on more than half of the first 50 trading days of the year. For each year, the analysts also show how the index performed for the remainder of the year.
If you have been overweight small caps heading into 2016, the analysts conclude, it has no doubt been a tough year, but history suggests the sun will shine again. As you can see in the table, in the 10 prior years where the Russell 2000 under-performed the S&P 500 on more than 25 of the year’s first 50 trading days, small caps outperformed large caps for the remainder of the year seven out of 10 times for an average rest-of-year gain of 19.3%.
The Bespoke data shows that the Russell 2000 was positive for the remainder of the year in eight of those 10 years. The S&P 500 meanwhile, saw an average rest-of-year return of 13.7% with positive returns nine out of 10 times. If this year works out the same as these averages, it will a very welcome surprise.
Best wishes,
Jon Markman
