Cumberland Advisors Market Commentary –  Two Covers; Two Sectors

Author: David R. Kotok, Post Date: June 2, 2020
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If you looked at the two different covers of The Economist for May 30, 2020, you saw the 100,000-death message on the American version, and you saw the Hong Kong security law depiction on the Asian edition. Internal content was mostly the same, but the lead stories reflected the world as the Economist editors saw it and wanted to portray it to their readers.

The-Economist-Covers

In my view, The Economist is the finest weekly global news magazine in the English-speaking world.

In the US, the contrasts in economics and financial markets are extraordinary. The stock market is setting recovery new highs, one after another. See the May 29th “Week in Review” video by Matt McAleer and the charts he uses in his discussion of the trading strength of this monster rally in the US market (https://youtu.be/isgC8sSacEI).  Anyone interested in those charts can email me, and I will ask that they be sent to you. At least one viewer found them hard to see on the video (beginning at 2:47).


 

The US higher-grade bond markets seem to be calming down. John Mousseau talks about them at the beginning of the May 29th weekly video clip linked above. Readers who like the Mousseau beard or who dislike it are invited to send an email to John and voice an opinion. There is a charity bet underway, so feel free to make your opinion known directly to John.

You can get the sense of Cumberland’s various portfolio positions from those two clips, so I won’t take time to repeat the points John and Matt make here. But there is an additional portfolio issue worth discussing that last week’s videos did not cover. The issue is what will happen to the US dollar in the FX markets and how that will impact the Energy sector and the Materials sector. The two covers of the Economist help frame this debate.

What is happening to Hong Kong is a geopolitical shock. A Cold War of words is intensifying between the two largest economies in the world. Some of the policy issues are troubling. Why fight with the WHO in the midst of a global pandemic when you need to achieve globally interdependent and curated outcomes in treatment and vaccines? If the US wants to pressure China, why not move for Taiwan’s admission to world bodies like the WHO instead of withdrawing (running away from the fight). Why not open the US visa program to Hong Kong citizens like the UK just did? We have done that in the past with Hungarians when a similar power shift occurred. We did that with Cuba after the Castro power grab. The intellectual property transfer to the US from China (Hong Kong) and the brain drain we could impose on China would be enormous. All could hugely benefit the United States.

Hong Kong is a monetary and financial center, and capital flight is underway. America can benefit immensely by attracting the flows and the talent. Our doing so will alter the US dollar for the benefit of the United States. We are still the strongest financial center in the world.

The two Economist covers also reveal the underlying determinants of stock market participation for the Energy sector and the Materials sector. Both sectors do well when the world’s economies are growing. Both are weakened by worldwide recession or depression. Both require longer-term capital investment, and neither can turn production on or off in a split second. Opening or closing a mine or shutting down a natural gas pipeline or drilling platform takes time and costs money. Companies try to manipulate the volumes rather than make “on or off” binary decisions. The COVID-19 shock was abrupt and not a business-cycle transition. If there is no second killer wave, the economic bottom at a very low level is happening now, and the recovery will accelerate for the rest of the year. Coming off such a dramatic and extreme shock means that the initial phase of recovery will be robust because it starts from such a low point.

Recovery means that demand will increase in the Energy and Materials sectors, though we do not yet know how fast demand will increase and in what components. And remember, both sectors are global in nature, and most commodities are traded and priced in US dollars in their worldwide trading regimes. This is where the two covers of the Economist come together. One cover warns about the fluctuation of the US currency and the geopolitical risk. The other warns about death and disease in America and the vast divide in American politics. The tragic death of George Floyd and the events that have erupted in response only confirm how fragile the American civil society has now become.

At Cumberland, we are in constant discussion about the Energy and Materials sectors. Matt McAleer and I have talked about them, and our research focused on them every day of last week. Energy, for example, is now about 3% of the capital weight of the S&P 500 index. That is a remarkable low point in the entirety of the post-World War 2 period. Having traded the sector twice in the last few years and lost both times, we are warned about the old adage, “Fool me once and shame on you; fool me twice and shame on me.” Do we take a third attempt with the Energy sector? The same logic can be applied to the Materials sector.

We have taken overweight positions in alternative forms of energy. We are overweight the solar and wind-power sectors and also hydroelectric power as part of an ESG strategy. In fact, those positions are very heavily overweighted in our US ETF portfolios. We would point to the new Gemini project in Nevada as a billion-dollar solar power structure that will power 200,000 households: “U.S. Approves Giant Solar Project in Nevada,” https://www.wsj.com/articles/u-s-approves-giant-solar-project-in-nevada-11589216400. For readers who want a lot of detail about why that move makes sense now, here’s a link to an in-depth discussion on solar power: “Solar’s Future is Insanely Cheap (2020),” https://rameznaam.com/2020/05/14/solars-future-is-insanely-cheap-2020/.

Two covers, two videos, two sectors. As of this writing, Cumberland hasn’t bought any direct positions in Energy or Materials. Please note that could change at any time.

David R. Kotok
Chairman of the Board & Chief Investment Officer
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