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Good morning. The jobs report on Friday was not nearly as bad as investors feared. The US economy added 151,000 jobs in February, below most economists’ predictions but not by much. Unemployment increased, but only from 4.0 per cent to 4.1 per cent. This still suggests some weakness; we are probably below break-even jobs growth. But for now, the economic vibes shift remains mostly vibes. Email us: [email protected] and [email protected].
The staples/discretionary ratio
Stock market leadership has changed a lot this year with international equities overtaking US equities, low volatility stocks overtaking high vol, the average S&P 500 stock overtaking the Magnificent 7, and so on. One of the flip-flops that gets the most attention is consumer staples stocks overtaking consumer discretionary stocks — a classic signal that the market has become defensive and economic weakness is in the air.
Here is the ratio of staples to defensives over the past five years, plotted against the performance of the S&P 500:
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What happened in 2022 illustrates why the recent spike in the staples/discretionary ratio is making people jumpy. The rise in the ratio that year coincided with a miserable run for stocks (and bonds), as inflation proved sticky and the Federal Reserve increased its policy rate. Only when the ratio reversed did the equity rally recommence.
One should not read too much into the ratio. It is not a leading indicator. When people are nervous, they tend to buy staples, and when people are worried markets also tend to fall. The ratio is simply an indicator of investor sentiment.
And it may be an imperfect one right now, because of the staggering run of the Magnificent 7. Amazon is now nearly 40 per cent of the discretionary index and Tesla is another 15 per cent. Those two stocks have fallen 12 per cent and 36 per cent, respectively, since January 6, when the staples/discretionary ratio began its rise. The remaining stocks in the discretionary index have only lost 1 per cent of their value over the period.
This observation urges two conclusions. First, the most important shift in market leadership remains the collapse of big tech. This change has received less attention than it deserves because it does not fit with the dominant market narratives about a slowing economy and tariff policy. Second, the investor sentiment signal from the staples/discretionary ratio is not quite as strong as it looks.
It is, however, still a signal. Here are the ten largest positive contributors to the staples index since early January, sorted by change in market cap. They are all absolutely classic safety plays, from tobacco to soap to soda. Almost all of them are also up by double digits in percentage terms.
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Investors are nervous, and defensive stocks are working. Fear is one element of what is happening in the market, just not the whole picture.
The oil price is in your hands, Mr President
Last week was chaotic. With so many headlines about tariffs — or the lack thereof — you would be forgiven if you missed that the oil price hit a three-year low on Wednesday:
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After months of delays and debate, Opec+ finally pledged that it will lift its production cap in April. At the same time, the market is fretting over what looks like slowing US and global growth. Together, they could mean that more supply will hit the market just as global demand steps back. A global oil glut might be coming.
There was a small rebound on Friday, after a Russian minister suggested that Opec+ could back off the production boost to protect prices, and after the US’ new energy secretary Chris Wright promised to buy $20bn of oil to fill up the US’ strategic reserve. But that was just a momentary reprieve. On balance, it looks like we are set for cheaper oil. Brent futures took a steeper fall last week, and are currently below the spot price (“backwardation”), suggesting a future fall-off in demand:
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Opec+ is on path to boost production; even though they may walk things back, that they have taken this long to schedule the change and that it has come with so much internal discord suggests that the cartel could be slow to pivot again. Some analysts also believe that oil demand by China, forever the swing buyer in the global marketplace, has finally peaked — Chinese crude oil imports were down 5 per cent in the first two months of this year. That leaves tariffs as the potential deciding factor.
The Trump administration definitely wants cheap oil — Trump and his advisers have said so repeatedly. Before the inauguration, Unhedged and many other commentators pointed out that this is in conflict with the administration’s desire to boost oil output: if oil were to fall below $65 per barrel, the US average break-even price, the industry would step back. It seems to us that, with the mounting fears of stagflation, they are more likely to favour cheaper oil right now, rather than higher production.
But getting there during a tariff regime is not simple. Though the market’s recent movements suggest that higher tariffs will drag down oil prices by weakening global demand, there could actually be a short-run jump in prices. Twenty-three per cent of US oil consumption is oil from Canada; if/when Trump puts tariffs on Canada, it will take time for US-based refineries to shift away from heavier Canadian crude oil, driving up demand for lighter grades. Whether prices go up or down in the short to medium term will depend on how quickly oil markets can adjust, and how broad and severe tariffs are.
There is also complexity on the flow-through of oil prices to US growth. Though cheaper oil would be a boon to industry, it is not unabashedly good for US growth, as oil is now a big US export. Complicating things further, in recent years, oil and the dollar have become correlated, bucking their historical inverse relationship:
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If oil prices and the dollar go down hand in hand, US exports will become more appealing to foreign buyers with stronger currencies. It is possible, then, that a boost to goods exports from a cheaper dollar could outweigh lower US oil exports from cheaper oil, making lower energy prices a net benefit to US growth. But that, too, will depend on how severe tariffs are, and how fast markets adjust. And a cheaper dollar is not a panacea in Trump’s world; he has repeatedly stated that he wants to see a strong greenback.
If Trump really wants cheap oil, high tariffs could help get him there by slowing US and global growth. But with fears of stagflation mounting and the complex interplay of oil, the dollar, and growth, the trade-offs could hurt.
(Reiter)
One Good Read
Joseph Nye the soft power guy.