Finally, I think I get it!

I have been puzzled for many weeks over the apparent, lock-step action in the stock and oil markets. Whenever the price of oil dropped, equities would immediately follow. I questioned this, because I felt lower oil prices were a major benefit to every consumer and industrial user, even if it might create hardships for certain segments of the economy. The basic takeaway was this was good for us and all the energy-dependent economies around the world (India, China, Japan, Europe, etc.).

Thanks to a comment by Jon Najarian, who called out oil-producing countries’ sovereign wealth funds as the culprit. He indicated these funds, which include all types of investments (stocks, bonds, real estate, private equity, etc.) were liquidating US stocks (very liquid, very broad markets) to offset budget revenue shortfalls brought on by plunging oil prices. All of a sudden, I think I get it.

Of course, when the big stocks in the S&P can’t get a bid, with prices continuing to drop, this brings in selling on small and mid-cap issues, selling just because the market is going down. These are stocks that the wealth funds would never own because of liquidity concerns. Ergo, you get overall market weakness, not related to any real fundamental or economic weakness.

What is the magnitude of the sovereign wealth fund equity overhang?

Hard to say…according to the Sovereign Wealth Fund Institute, there is a little over $7.0 trillion in assets in Sovereign Wealth Funds (SWFs). Of the $7T, approximately $4T sits in the funds of oil producing countries. These funds are highly diversified. I am speculating and don’t know the exact composition of these portfolios, but it would be hard to imagine, as much as $1t being in US equities. But a Trillion is still big money. Although $1T sounds like a big number, if you take it in the context of trading in the US equity market, it is not. Last week (Jan 11.), according to The Daily Market Summary, nasdaqtrader.com, total dollar value of trading on all markets, where any nasdaq securities trade, was nearly one half trillion dollars. Nonetheless, it does represent a headwind, as long as crude prices are declining or remain low.

What’s Next?

Unfortunately, the market’s gonna do what the market’s gonna do.   Although the S&P and Dow closed virtually unchanged yesterday, the small and mid cap sector, as represented by the Russell 2000, took another hit, down 1.28% (at 994.87) on the day and 23% from its June, 2015 all-time high of 1296. This beating continues today, with the panic that was going on under the surface, emerging in full force throughout the market. All of this is happening in the face of fundamentals that do not seem to be falling apart. It is not surprising to see a decline like this end in an overall panicky sell-off… a washout.

Everybody has been looking for a correction of the huge move we have had the past three years. We are getting it in spades. Corrections are normal and painful. Keep the faith!

What is your take?

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