(Note: This report was first published to premium subscribers on 1/23. If you are interested, you can sign up here. Daily Pain is part of the HFI Research premium series.)
I hope everyone had a chance to read our Thought of the Week piece last week on the combination of using variant perception macro research with fundamental value investing.
Markets are now far too competitive and participants far too impatient to handle the volatility in the marketplace. The birth of algo trading funds has reduced broad market volatility, but increased individual sector volatility. For example, if the healthcare sector tanks 4% and industrials rise 4%, the net effect (depending on the weighting in the index) could cause just a minor decline or a minor rise. This stealth volatility, as I have observed, is one of the most dangerous things about the market place today. It creates this sense of false safety that many market participants have relied on, and the swashing of money in and out of sectors create the illusion that one can be a successful day trader.
This is especially important, in my opinion, for value investors to understand the context of certain sell-offs relative to others. For example, Canadian energy names sold off over 3% today. They weren't just any energy names, but the selling was mostly concentrated in higher-quality names like Raging River Exploration (OTC:RRENF), Peyto Exploration & Development (OTCPK:PEYUF), Tourmaline Oil Corp. (OTCPK:TRMLF), Arc Resources (OTCPK:AETUF) and others. This phenomenon indicates two things to me: broad macro implications or a fund is reallocating out of the Canadian energy space.
Trump's presidency did not start off like how most expected it would. His press conferences have not instilled a lot of confidence, and his focus on how the media covers him is a bit concerning. This is also why the idea of a protectionist government policy could damage global growth rather than stimulate it. It's far too early to tell, but I see most fund managers take the "shoot first, ask questions later" approach as they dump Canadian energy stocks.
The other implication could've stemmed from weak commodity prices, but given the significance of the decline, it looks to us that the sellers today favored high-quality energy names today. High-quality names have historically outperformed commodity prices.
In my eyes, the recent sell-off is the broader rotation I highlighted earlier in the year. Energy names were the biggest outperformers last year, so it makes sense for portfolio managers to take allocations up a notch to window-dress the portfolio for year end. With commodity prices lagging, the market for PMs to allocate into energy dwindled away, and the fake owners towards year end are selling out still. We should see this effect go away this week, and most of the names will start to rebound.
Today's piece won't be very long, but I think it's very important to watch out for the stealth volatility in the market. Be careful of taking broad macro sell-offs as indications of deterioration in fundamentals - that's the most dangerous mistake to make in investing.
Disclosure: I am/we are long PEYUF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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