The Risky Reality of Market Concentration ft. Ron Willian

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0:58Welcome back to Real Vision. I'm Ash Bennington. We're joined today by Ron William, CIO and and macro tactical strategist at RW Advisory. Ron, welcome back to Real Vision. Great to be back and happy summer greetings. Well, it's great to have you. Listen, Ron, we were talking before the show, lots to talk about in the macro space. Rotation, what's happening in US equity. It's just so much happening right now that's grabbing the news cycle right now, mid-July 2024. Ron, where do we begin? Well, a quick recap on the approach that it's global cross-asset macro top-down. ultimately grounded in behavioral technical analysis and driven by cycles.

1:38I'll just pin that as a reminder or refresh for those watching again. But what all of that means is as part of the mix of the business cycle changes in season, we continue to be in this greed and fear rotation. And that's probably one of the key feature charts that I think helps illustrate the picture of what might be happening right now. But just before we jump there, we have an opening humorous but insightful cartoon. Picture speaks a thousand words, cartoon even more. And it's a credit to Ed Hegei. the bull in the water being held up by these inflatable balloons, no surprise, it's the MAG 7, 5, and now 3 or 1, depending on which one is leading and which one is not.

2:33Of course, there is a rotation between the best of the best and now the laggards year-to-date in terms of value. We can speak a little bit more about that, But the long and short of it is it seems to be fast rotation, not sustainable. And although the rally is extending higher, it's getting thinner and thinner, more fickle and fickle. And there's lots of divergences that are developing. Well, Ron, let's talk about that. And I think this is just such a great cartoon. Everybody who watches markets sees that. They get the joke immediately. We all feel it, this sense of high concentration, a lack of market breadth in this rally, record highs on U.S.

3:15equity indices. And yet this sense of maybe, I don't want to be too sort of overstated, but there is a little bit of like ominous foreboding, right? With this sense that, gosh, it is just these, you know, as you say, three, five, seven stocks, one, that are propping up the market. How do you think about that? How do you measure it? And what is it that it says to you about the broader context of U.S. equity markets? Well, it's the same story that That remained true for most of last year. Concentration risk was exactly that story. And yet the market stayed strong, not for the entire time. It did ebb and flow.

3:52We did have a big drawdown in Q3. My view is we will likely have another one this year coming up from August onwards, especially ahead of the US elections this year. More than any other year, we've had geopolitical and election-related volatility, 40 or even 70, if you want to total it up, plus elections around the world. And they're all make or break events in terms of market impact and in terms of polarization. And a lot of uncertainty that remains with us, if not, has increased. So all of this means is we still continue to trade the markets. And if it's going up and you're long, stay in it.

4:35But prudence is key. And being able to take profits when necessary, looking to hedge, particularly as we go into this negative seasonality window of Q3 from August onwards. And everyone knows that the best pattern of it all is September and October. That's when vol typically spikes up, particularly when the Sharpe ratio has been at record complacency levels for most of this year. I should say, by the way, that we're recording this here Thursday, July 18, 2024 at around 3.30 p.m., just about 30 minutes from market close. And what I'm looking at on my screen is a whole lot of red ink. Russell 2000 is off some 2 % on the day.

5:16S &P 500 down about a percent. Dow Jones Industrial Average down a little bit less than one and a half percent. You know, one of the things that, you know, gets discussed with this equity market. Well, there are really three things. It's all-time highs, number one. Number two, concentration. And number three is the rotation that we've seen into and out of small caps. Talk a little bit about this. Those are sort of the three major themes that I see in play. How do you think about it and how do you reconcile those positions? So I believe there's this thesis, which has existed for some time now, dubbed the behavioral inflection point.

5:54I truly believe that we're in this late stage cycle on borrowed time, but more importantly, this bull trap in action, in motion that is going through. Now, timing it has been hard as hell. And that's, of course, what we've all been watching our screens and trading our book in terms of keeping it focused on market price action, keeping our biases in check. and then applying risk management where necessary. One way that I help stay objective is this opening chart here, which is my radar screen from week to week, looking at a cross-asset rotation, which currently shows a transition between greed and fear.

6:44And there's always been this biification for some time in the markets. Now, just as a brief explanation of what we're looking at, it's three columns measuring trend over time. So the motion of trend and cycles as it changes. And from the left to the right, you have a long-term strategic, middle, tactical, medium-term trend. And then on the right, active short-term. What it shows is you have... So that means that basically moving from left to right, you have longest time duration to shortest time duration. And moving from the bottom to the top, you have the weakest, the strongest. Exactly that.

7:24And basically, when you have, and it's color-coded in terms of asset class, it is cross-asset. And when you see the same asset class rising across all three timeframes, then it's a strong trend over time and vice versa on the downside. Sometimes, as is the case now, you get a little bit of flip-flop and fast rotation between each of the assets. And typically we get a risk on risk of consensus or broad global trend. That's not what we've had for a while. So equities have obviously been elevated for some time as part of that risk on proxy, Bitcoin, coupled with that. We're seeing both of those greed assets for now unwind.

8:08And as you just saw, you know, at time of this interview, we're seeing a little bit of a tactical mean reversion. One thing I would highlight to everyone is that chart on the right, top right, figure two, S &P 500 testing its short-term tactical 20-day average. And that's support levels at 5535. So for when they watch this back, we're either testing it or breaking it or holding. Time will tell. But that's definitely showing up on the radar screen. And you can see in blue, USA has been topped right until very recently on the latest drop that we've seen. So it's had a full-front grace, so to speak, while safe haven assets like gold, which is acting like real money these days, remains elevated, even though it's sideways and consolidating.

8:57And then we have emerging markets still leading the way, such as India. and then look at the bottom in terms of the negative outliers rates just going through a tactical unwind although my view is still medium to long-term bullish higher for longer as part of a long-term cycle view and an analog going back to the 1970s and then if we look at the commodity story which i've been bullish for year to date that is now unwinding as as it became overbought too much too soon. You can see copper down at the bottom.

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10:40Well, this is such a great slide that we're looking at. This is just truly rich, information dense visual that you get from that. And, you know, my takeaway is when you just look at the points you just made, boy, first of all, when you look at the weakest, it's just 10-year treasury at the bottom across all time horizons. And then look at the top. I see gold, gold, gold, and pinned to the upper left hand corner, which is the strongest strategic play, gold. I mean, so gold, gold, gold, all time highs. And although it's going sideways in dollar terms, which is what everyone is typically watching, check it out across world currencies.

11:16I think on some platforms, it's WCU for world currency. and you'll just see it's also at all-time highs. So you'll get some ebb and flows variations based upon different currencies. The pound here in the UK is strong post-election. So you're likely going to have more buying power on that side. But generally speaking, whether it's the major currencies, the emerging markets or some of the gold resource markets, gold has been holding strong. And that's partly a commodity story, a FX debasement story, and just a strong trend story that remains holding. And of course, from a relative performance perspective, gold remains attractive, as does silver, as a high beta play.

12:06And these are things that people can keep in mind. And just to complete the picture of this chart mosaic, bottom right, figure three, watch change to the macro side from a behavioral point of view. and that's the main focus of my work, behavioral sentiment fueled by cycles, we can see this right here and now in terms of macro surprise indices, below zero for the last, in recent months. You can see that's across three, Citigroup, Bloomberg, and Goldman Sachs. And of course, that's slower GDP out of the US. That's, I mean, stickier inflation than expected. And then more recently, the labor numbers, which seems to be a little bit skewed right now.

12:48But still, it's keeping many of us guessing in terms of how all of that is going to unwind in the second half of this year. You know, the more I stare at this slide, the more I see, and it's really a great one. The other pattern that I just noticed, which is really interesting, is China versus the USA. When you read this chart from right to left, like Arabic or Hebrew, you see this gradual step down in China from positive sentiment for relatively moderately positive or neutral sentiment, I guess, from the shortest term time horizon down to weak from intermediate time horizon and then weakest over the longest time horizon.

13:30Conversely, when you look at this chart from left to right, you see the exact opposite. You see the strongest positioning and the strongest quadrant for the US over a longer strategic time horizon. Then you see tactical a little less strong. and then you go to weak from an active perspective. It's really interesting to see that because what it essentially says is kind of the opposite of probably the broader story that we've been reading about for decades at least, which is you see a secular deceleration in the strength of Chinese markets, according to this table, and a secular strengthening for US.

14:07I don't know, am I reading that wrong? Absolutely correct in terms of the latest rotation, which is basically the elastic band effect. I mean, everything that's been strong is now unwinding from up to down and then vice versa for this market, China being a case in point, although that was catching the falling knife phenomena for some time. And there are some China bears out there that are also concerned on the macro side. So it depends on your view. But certainly the alternative to China for a lot of Asian clients that I work with and some here in the West has been Japan. And of course, that remains strong and less macro or geopolitically of a concern.

14:48But then your point about timing. Yes, so I would only reframe the word secular, which I do use in my cycle work. Secular typically alludes to multi-year, sometimes multi-decade. Here we're looking at, if I were to simplify in calendar timeframes, tactical monthly, sorry, active monthly, tactical quarterly, and strategic annual. So if you just think about literally those calendar dates that dictate our lives and our portfolios, that's essentially what we're doing. I add some relative performance and some timing cycle filters. But the reason why this is so powerful is it just keeps us all on track in terms of that cross-asset rotation mix.

15:39Sometimes it's just traffic light signals and there's a lot of gray, so to speak, in terms of noise in the market. Right here and now, we're starting to get some tangible lead signals over live rotation. And of course, it's also a confluence that is taking place. And our next slide focuses on why I'm more concerned now than before, because of this ongoing triple whammy headwind. And what I've basically pinned down to three factors, momentum extremes, rotation, fragility, and cycle risk. And we just touched on the first two already in terms of the all-time highs and in terms of the opening cartoon about the bull sinking in the water, but still holding that concentration risk in the hot air balloon.

16:30So with some rotation that's been taking place. Now, if we just look at the charts in terms of big picture of what's happening, that behavioral inflection pattern that we've been discussing at the top here, I've now redubbed the runaway behavioral inflection pattern because clearly whenever we get an unwind, we just run up again. And now we're thinning out into this narrow momentum market as well as rotation. Now, the trend is our friend. Don't fight the trend. Don't fight the Fed or anything else that looks like a moving train. But caution right here and now as we get the market unwinding from super overbought conditions.

17:15And probably the best thing to do in this type of environment where the market is leading despite so many different dislocations, tactical and strategic, is to wait for a potential rollover. And the key level there is the 20-day moving average, as I just highlighted, at 55.30 for anyone who's trigger happy or just waiting for another signal. But then more than that, I would say any signs of momentum exhaustion will likely lead to a bull trap signal. Think about all of those super bullish, leveraged investors and traders suddenly getting it wrong. once that flips from up to down it creates a big squeeze and that's why these these types of elevated uh thinning out market moves tend to uh end in dramatic way and you can just see their support levels i've drawn in my chart and this rising channel from two years ago which we've broken out of any potential unwind back to mean erosion risk to the downside at the very least you've got it you've got a 10 to 20 percent downside which would be super healthy and more than likely within the time frame of Q3 from end July into August which tends to be the peak out zone on a seasonality basis and if you just see here on the right top right figure two this was one of the reasons why I was still bearish up until we had this fast rotation, you know, fueled by all that liquidity.

18:55S &P 500 equal weighted and the Dow and the Russell were making multi-month lower peaks as tech and MAG were leading on the upside. Now we've had a flip side, but the question is how long does that hold? So if we look at S &P 500 equal weighted, going back to its year-to-date high or the Russell, which it may, because it already is looking a bit too sharp on the upside, then that'll be a lead signal of changes. And obviously with the VIX being so low, that also gives us further upside into where we were March and April around the 19, 20 % handle. I want to get one of those little crowd counters so I can click every time you say bull trap.

19:47well they're the most effective patterns in the world uh it's essentially it's a bullish pattern that fails and that's why it works so well uh because it's it's a big blind sight uh for for people in the market including us um so you know if we're too early uh to call it obviously if it's proven out wrong um but uh if and when it does work and history's proven that many times what goes up eventually does come down then the bull or bear trap trap being the buzzword um is is the key behavioral pattern to be watching along with all the other pattern setups that i'm sure rv videos uh viewers will be uh trading the second point uh as part of that triple whammy factor is exactly what we're touching on and it was that opening cartoon again of the bull sinking the water with the hot air tech balloons.

20:41Rotation fragility. Now I'm going to get a little bit techy here with a composite breadth signal, which has been in usage for decades. It's got an ugly name. And for that reason, it's got a little bit of a bad rep. It's called the Hindenburg Omen. All that means is watch out when it triggers because usually there's a big drawdown or crash. I'm just going for a healthy drawdown crash if and when it happens. But the last time we did see the signal was 2019 and other notable times. It doesn't work all the time, but it does coincide with tops. And just as a quick explanation of what it is, three things, strong uptrend, demonstrating signs of exhaustion, high-low expansion, and negative breadth.

21:30So we've ticked those boxes for some time now, still watching the signal to see if it plays out. But essentially, it's telling us what we already know, but on a composite index basis, that this rotation is actually starting to be a problem right here and now. And if you look at the right, historically, just to add this big picture context, top right, figure two, this is as extreme concentration risk as Y2K. I think most Real Vision audience members already know that because that's been headline news for a while. But that's remained an issue, right? I mean, that still tells us the elastic band is stretched.

22:09So while it hasn't snapped back, it's still stretched. And it's still something where we should caution. And whenever I think about this or talk to clients or even review the portfolio, the one thing that gets me more concerned now than before, when we've had concentration risk for a very long time, is the fact that now there's a domino effect within the concentration risk. Not only is it historic Y2K extremes, but now we're going from mega cap 5, 4, 3, 2, 1, where I think Nvidia in recent weeks was worth about 30 % of the year-to-date performance in S &P 500 alone. And while Nvidia is an amazing stock and currently wobbling as we speak, take care because that high beta, high concentration is a risk.

22:59Hey, everyone. We're going to take another quick break and hear a word from our partners, and then we'll be right back. It's really an interesting chart to look at this, and this isn't one that I'm familiar with, but it is really interesting to see those three kind of peaks on the right, 15, 19, and 24. with 24, it looks like now finally tapping over 19. But when you look back to the left of those charts, man, 2007, 1999, and 1989, those are like ominous red letter dates in US equity market history. It's a powerful indicator, which has an ugly name. And when it works, it's something to watch out for.

23:43But it's certainly one that we have to kind of have our biases and check for and wait for the market to actually trigger and confirm. And keep in mind, it's telling us what we already know. Market fragility is an issue. And this is just giving us a composite measure of that issue, just to ring that bell when the market has likely crossed the line. We still need to wait for price confirmation. We still need to wait for follow through. But certainly, it's something that should keep us alert. Amber light, not red, not green, but certainly amber. Ron, let me ask you a question because you made an important clarification earlier in the show between the way you use the term strategic and structural annual and then longer term cycle basis.

24:29When you look at this indicator, and I know you have some other charts that we're going to go and hit in just a minute, but what sort of time horizon are you thinking about this on? In terms of the potential mean reversion, late cycle stage that we're at. So I think this year holds up. I think if we do get a correction, it'll be healthy, maybe fast, but limited. I think we have a bigger risk ahead into 2025 and beyond as part of a multi-year shift that will take place. And we've been on borrowed time on a macro long-term basis for some time. If I move back to the actual process, it's based on a roadmap boom-bust cycle developed by my mentor, Robin Griffiths, a leading macro strategist that actually we interviewed together.

25:27It was a great honor and pleasure to do that in a Real Vision studio here in the UK. watch back for that long-form discussion. But essentially, we discussed this model, and we both agreed that we were still late cycle between WXY. More detail in that interview. But that model is based on these economic cycles. So to your question, secular mega cycles, the top cycle on this chart is the one that influences interest rates, And that's an average of 54 years. So most people ignore it because it's just too big to care about. But in 2022, when we had an inflation and rate shock, that's when this cycle became on everyone's mind, whether people knew about it or not, because we had a cost of living crisis.

26:20We had geopolitical flare ups and we had a big move on rates, which broke a 40 year trend, downtrend on rates, U.S. 10 yields. And that is still looking like a rolling wave of volatility with a higher for longer trajectory ahead. Although we're unwinding now, my view is still bullish for rates. And one of the big picture charts that we had in that long form discussion with my mentor was the 1970s, where we had three sequential rising waves of inflation. We're in the middle part where inflation is more than halved. It looks like happy days, but we're just about to make a low before we pivot and then rise again.

27:04So I do see higher rates perhaps into year end and the new year fueled by the debt situation, but we will likely see it in the commodity complex. And if you look at a ratio of commodities versus equities, super stretched in favor of commodities, also another chart that we discussed in that interview. And just a quick fast track, the other cycle is just to complete the answer to your question. The jugular or average 10-year cycle is your long business cycle duration. The third down is a variation of that, which is more correlated to the U.S. presidential election cycle, which is super important this year because we're months away.

27:49And remember, we already have double-digit elections around the world, I think. close to 70 plus, all very important and all very uncertain. And then right at the bottom, the one that people can trade more tactical, and that is seasonality in terms of 7 may go away, which didn't work so well. This year, the one part that is the most reliable part is the September, October drawdown list, which we're heading into. You know, it's really interesting. First, I should just say, I'm relieved to see there's a cycle whose wavelength is actually longer than I've been alive. That's reassuring somehow. But let me ask you this, when we talk about this, and I know that this is tricky and interesting because you're looking at this along different time horizons, but I want to dig in here.

28:32So it sounds like what you're talking about is a short-term cyclical snapback followed by a potentially longer-term decline in 2025. Let me ask you this. In terms of the percent drawdown that you see for the near-term cycle, where we could be in 2024, What do you think that might look like based on the data that you guys look at for this cycle? So it's market dependent, of course. The markets that have risen the most will suffer from that elastic band effect, as we discussed. Remember that rotation chart, U.S. equities is top of the mix of what was strong and what is now unwinding. And as you quite rightly highlighted, and good shout on your part, the opposite is happening in the rest of the world.

29:20So developing markets which are underperforming the US are now starting to, I don't want to say the words, outperform, but they're certainly starting to be constructive now and may improve over time. China, open question mark, but certainly others as well. Now, in terms of the move, I invite everyone to draw this trend channel on S &P 500 over the last two years, but also use the 20-day average as a tactical timing tool where it currently is finding support at 5536. If the S &P 500 breaks below that and we get a reversion on S &P 500 equal weighted telling us that this rotation did not work, was short lived and ultimately failed, then be aware of that behavioral inflection pattern, which is a bull trap, which could have some fast vacuum drop levels into 10 to 20 % at the very least.