All About That Strait

One-Dimensional Market

Soundbite: Last week we highlighted the recessionary threat associated with oil doubling from its 2025 $55 lows to $110 in WTI Crude futures. Stock market direction has been hijacked by investor focus on the diminished crude supply, which has driven crude higher and widened Brent’s premium to WTI crude futures. The flow of oil in the Straits of Hormuz is the determining factor, which in turn is a function of the length of the Iranian conflict. News of securing Iran’s half-ton of enriched uranium may determine when we can put this crisis behind us. At that point, investors can turn to other market drivers such as earnings growth and deregulation, or Nonfarm payrolls, AI-disintermediation, and private capital portfolio company delinquencies. Those market elements, regardless of their importance, are temporarily swept aside in what we call a one-dimensional market.

We adhere to our personal theory of Variable Dimensionality, where historically, the top three out of an army of factors explain price changes and capital flows in risk markets. As conditions change, a risk factor that was once inconsequential can suddenly become critical—inflation’s emergence after post-COVID stimulus is a recent example. There are brief periods when those three factors collapse into one, creating volatile and hectic market conditions. Currently, the uncertainty surrounding a Middle East resolution keeps open the possibility of oil tipping the global economy into recession, despite the likelihood that we have hit an extreme.

As of last Monday, the markets had assumed roughly a one-month horizon before a resolution, and WTI crude futures rose over $10 from the pre-invasion base price of $65. Last Friday, futures shot up by a similar amount following Trump’s Thursday announcement of no longer being indifferent about Iran’s successor. His shift caused the consensus to extend their timeline for the conflict. He then moved the goalposts to “unconditional surrender,” extending investor expectations into an open-ended, prolonged engagement. The result was the overnight push in WTI crude through our $110 demand-destruction target. Hitting Iranian refineries and storage depots this weekend did not help matters. Of note, the Chicago Mercantile Exchange increased margin requirements on a variety of energy products, but not on the main contract, WTI crude (the CME lowered margins on gold and silver due to reduced volatility).

Because petroleum and natural gas products are key inputs across supply chains, energy traders use a rule of thumb stating that every $10 increase in crude causes a 0.3% contraction in consumption. Using this heuristic, we are talking about over a 1% hit to consumption.

Any solace for equity traders?

• The dizzying increase in crude from $65 implies a fear of Middle Eastern turbulence through June. With affordability issues being the swing factor among voters, June collides with the mid-term election cycle, making the situation untenable for the GOP.
• As we pointed out when our top-end $120 target in silver hit at the end of January, the daily ranges in WTI futures have become enormous, a hallmark of a blow-off top. However, because we are in a one-dimensional market, we cannot rule out further price extensions.
• The specter of an expiration date on the President’s ambitions could keep the Saudis from becoming militarily involved. Why would they enter a war if they believe there is a reasonable chance that the Trump administration backs out and the Saudis are left embroiled in a war they did not start?

Finally, Japan has released plans to tap its national oil reserves, with many hoping the U.S. will follow with releases from the Strategic Petroleum Reserve. There are rumors that the stored oil is unusable as it has degraded, pushing crude prices even higher.

Regime Change: Goodbye to Beta Support on this Break in the S&P

Soundbite: Even if we are witnessing yet another failed breakdown that will lead to new highs, today’s dramatic gap below our long-standing 6720 major support level in the S&P 500 changes the investment landscape. Confusion abounds: Morgan Stanley is constructive over the next six to twelve months after the dust settles, while JP Morgan is open to the possibility of a drop to 6300. Regardless of how near-term weakness plays out, what matters is that the break below 6720 in the S&P 500 signals a turning point.

As we have outlined exhaustively in previous Points, today’s breakdown is market confirmation of a structural shift sparked by changes in the inflation outlook that will continue to be aggravated by profligate fiscal policy. These factors, combined with a geopolitically volatile market backdrop, have ushered in a period that rewards strict risk management, controlled asset allocation, and deliberate security selection. Be open to new geographical investments and new ways of sizing and constructing portfolios. The days of riding high on the back of equity market beta are over. Thankfully, there is a silver lining for those who are willing to change with the new environment.

We are leaving an era where assuming more risk always adds to incremental returns.

That fact is consistent with top-heavy concentration in the broad indices, narrow credit spreads, and lowered expectations for risk-parity portfolios. Investors are now starting the next three- to five-year investment horizon with elevated valuations, dampening forward returns. Additionally, the fact that yields move inversely with stocks during inflationary periods eliminates any performance hedge that bonds had previously represented. With high inflation, both stocks and bonds move together based on changes in inflationary expectations, and as expectations rise, bonds and stocks fall in concert. This is the opposite of what has happened during deflationary growth, when both asset classes are driven by changes in real growth forecasts, which push stocks and bonds in opposite directions.

Furthermore, geopolitical and fiscal influences can flare up and hit both equity and fixed income asset classes simultaneously, compressing Price/Earnings ratios and raising bond yields. This is a harsh reality that investors have been reminded about recently.

The good news is that those who are flexible and make the leap to adopt a new approach—one less reliant on pure Beta and more focused on Alpha through a disciplined and consistent investment process—will be rewarded. While absolute returns may be compressed compared to the last three years, incrementally better relative returns will not only retain clients, but earn new ones.

Gauging Peak Fear in Private Credit: BDCs CLOs FRNs

Soundbite: Paradoxically, as anxiety builds over private credit, in a world of capped equity returns (in part due to problems in the private markets), private credit tends to outperform. The challenge with a falling private market is determining whether prices have dropped enough to spark demand. For clues, we can look at the large private equity firms such as Carlisle, KKR, Apollo, and Blackstone, as well as Blue Owl, all of which are publicly traded. They are falling precipitously with KKR cut in half from its peak, which had represented a 10x appreciation from the 2020 lows. However, KKR and APOL have not broken last week’s lows despite broad equity selling at today’s market open.

Many private credit funds access the Collateral Loan Obligation market to lever themselves, and we are looking for bottoming signs in ETFs such as Janus Henderson B-BBB CLO (JBBB), which is strong today. Finally, most private credit is floating rate, so we are following the BlackRock Floating Rate Loan ETF (BRLN), which is also outperforming on the day.

Like KKR and APOL, JBBB and BRLN have not broken their lows from last Monday, a sign, albeit fragile, that investors are beginning to find value. It is imperative to put these two CLO and FRN ETFs on your radar along with Business Development Companies such as KKR and APOL, to compliment USO (WTI crude oil). We like to look at the weakest performers for signs of a turnaround, and while Blue Owl (OWL) is trading below last Monday’s low, it is trading this morning at levels that found demand in 2022 and 2023 and reversed its price trend upward.

Many are concerned that markets are on the doorstep of a nightmare scenario of forced liquidations, bringing back memories of 2008.The truth is that we could be experiencing a “sell the rumor” scenario, and the time to “buy the news” is approaching. How to find out? As always, we defer to the market to tell us when it has bottomed.

When broad indices make new lows, it is often an important market tell to see which stocks, industries, and sectors are holding up. That is why it is necessary to track signals in publicly listed private equity shares and monitor associated markets such as Floating Rate Notes and Collateralized Loan Obligations for washout clues. Financial ETFs such as XLF are also part of this analysis because commercial banks are major lenders to private credit and private equity sponsors. The selloff in this universe is tied to the fact that as portfolio company defaults rise, Wall Street lenders of CLO instruments can force funds to pay back these lines of credit. Despite efforts to make portfolio companies look more profitable and skirt being classified as delinquent, if the economy slows further, defaults will rise because refinancing rates are higher, especially for funds from 2021-2022 that levered in an ultra-low-rate environment.

The fear is that Wall Street firms, not wanting to be left holding the bag (remember Margin Call: Be First, Be Smarter, or Cheat), may preemptively pull credit lines from PC funds, creating forced liquidations into a thin market. This is how systemic risks arise.

It may be early, but we are looking for signs of selling climaxes this week.

What to Look for This Week

(All times D.S.T.)

1. Wednesday, March 11 at 8:30 a.m. February Consumer Price Inflation and Friday, March 13 at 8:30 a.m. January Personal Consumption Expenditure Price Index. The CPI January report showed annual core CPI at 2.5%, the lowest since March 2021, but as we have outlined, the annual data will be distorted for a while due to the shutdown. The annualized monthly data was a more realistic 3.6% and annualized supercore (services ex-housing) was the strongest in years. After months of steady 0.2% core PCE readings, December came in at 0.4% and expectations are for a January print of 0.3%. Old data, and one week away from the FOMC rate decision, which is expected to keep a rate cut on hold, especially considering the Iran uncertainty. Watch monthly CPI statistics and Shelter inflation on Wednesday morning, with an eye toward Used Cars, which was depressed in January due to reporting quirks. The Cleveland Fed Inflation Nowcasting service expects the monthly core to rise at only a 0.2% monthly rate for February and March, which would be a bullish development.
2. Tuesday, March 10 at 10:00 a.m. Existing Home Sales for February. This datapoint interests us because January sales plummeted by 8.4% vs. December. Its annualized rate of 3.9 million home sales was far below the 4.2 million consensus, which was high after December hit a 3-year high of almost 4.4 million sales. January’s drop was the most severe in almost 4 years, registering the lowest level since September 2024. It may have been due to weather, but affordability has improved thanks to lower rates to the most attractive levels since March 2022. Thursday, March 12 at 8:30 a.m. January Building Permits. Look for Single-Family Permits because they fell 1.7% in December and are a leading indicator.
3. Monday, March 9 at 11:00 p.m. China’s Trade Data for January. This is important as we discussed last week that China’s exporting flows could double over the next two years. The country posted a record $1.2 trillion trade surplus last year, with exports rising 5.5% as imports were flat. Production was shifted to Europe and Southeast Asia, For December, exports increased at a 6.6% annual pace vs. a 3% consensus. China’s trade surplus with the US fell to $23.25 billion in December, down from $23.74 billion in November, but that is expected to rise in time, as well.

FOMC Voters Speaking: We are in the blackout period so no speakers before the March 17-18 meeting. The March Quarterly Refunding of Three-year Treasury Notes kicks off on Tuesday, March 10 at 1:00 p.m., followed by Wednesday’s Ten-year Note auction and Thursday’s Long Bond auction of Thirty-year maturities. It comes at an interesting time as the expense of the Iranian incursion is increasing budget deficit worries. Fixed income investors will find out if yields have risen to attractive enough levels.

Earnings: Monday, March 9 Oracle Corp. (ORCL) after market for potentially more color on circular financing and cash flow with the stock on multi-year lows on an absolute and relative basis. After market on Thursday, March 12, Lenar Corp. (LEN) reports as mortgage rates and purchases seem to be moving lower together. At the same time, Adobe Inc. (ADBE) reports, after Michael Burry reportedly bought stock early last week after it has fallen almost 60% from its highs. ORCL sits at October 2022 lows, when the S&P was half its current level.

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By Peter Corey

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