Arguably the biggest event in global markets this month was the US CPI release on the 14th of November. Following the surprise drop in US inflation, the headlines read like ‘the harsh medicine appears to have worked’ and ‘US stocks accordingly threw a party on the news’ [1]. The Russell 2000 jumped by nearly 5.5% on the day, alongside a big drop in US Bond yields.
The US CPI print was bad news for trend-following strategies in futures markets. At the time of writing, the SG Trend Index was down -4.22% up to the 24th of November [2]. Inspection of the SG Trend Index [3] suggests that trend funds lost for two reasons. On the day of the CPI release, it was uniformly short across the entire bond sector and lost -1.79% on the rise in US yields. It was also short all currencies versus the US Dollar, causing it to lose -2.52% as the Dollar sold off. Since the SG Trend indicator allocates equal risk to each sector [4], this suggests that the move in the US Dollar was even larger than bonds, on a risk-adjusted basis.
Energy was a major cause of the fall in the headline CPI number. By the 22nd of November, oil prices fell more than $15 per barrel from levels seen in early September. Taking a longer-term view, energy prices have been volatile but range-bound all year. The nearest-expiry Brent Crude future has oscillated between highs of around $95 and lows of around $75 throughout 2023. This is a very challenging environment for the trend-following strategies predominant in commodity futures, which require a persistent directional movement. Oil is certainly capable of delivering these moves, demonstrated by its increase from a low of around $20 to a high of around $120 during the COVID years, a 500% increase.
In the Metal sector, gold and silver delivered strong returns in response to lower forward interest rate expectations after the CPI report. Like oil, these markets have been range-bound all year, making them a tough environment for trend-followers. Palladium stands in stark contrast to this narrative. At the beginning of the year, front-month futures prices were around $1800, but have fallen persistently all year. Recently, prices dropped below $1000, a 44% drop year-to-date and one of the best trends in the metal sector.
The difference is highlighted in Figure 1, comparing palladium to the congested price movement in oil, gold, and copper. Palladium is set to be a big loser in the green transition, being primarily used in catalytic converters. Copper, on the other hand, is used in electric cabling, which is obviously needed in large quantities to build out the infrastructure required for mass adoption of EVs and renewable energy, but so far this has not resulted in a stellar upward trend. With further rate rises seemingly off the table, maybe this could be the next big trend in commodities?
Figure 1: A Comparison of 2023 Returns in Select Commodities:
Only Palladium Has Sustained a Trend
Source: Bloomberg
Figure 2: Macro Factors Reverse on Rate and Inflation Regime Shifts
(Returns October 25 - November 24)
Source: Wolfe Research
Quant factors also notably continued their rally in November, led by High Frequency Quant, again highlighting the benefits of stock selection models that can rapidly adapt to a more dynamic market environment. As expected, on average Growth factors began to outperform Value factors, as it becomes more likely we have reached the peak Federal Funds Rate, and interest rates are likely to begin falling in 2024.
Figure 3: Quant Rally Continues
(Returns October 25 - November 24)
