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Relief Yes, But the Bears May Not Be Done Yet

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September 27, 2021
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Wow, what a difference a day makes. Tuesday night, we were staring at the edge of an abyss. After four days of substantial losses, with every rally failing miserably, the market appeared to heading straight for a chasm.

Wednesday, however, was a total change of pace. The market again shot higher overnight, bled down all morning, but unlike previous days, this time it launched skyward into the close of the day. By the time the buying rampage finished, the Dow found itself more than 600 points higher. It ended up being the strongest up day in four years!

And prices weren’t the only thing that reversed on a dime. Pundits who had been profoundly pessimistic just yesterday suddenly have refound their optimism. By the end of day, various folks on CNBC and other outlets were ready to say “all clear”. Supposedly, the bears have gone to hibernate, and it’s again safe to buy stocks with reckless abandon.

To which I say: Not so fast. Sure, I’m as glad as anybody that the market recovered strongly Wednesday. Things were getting close to the precipice, and it’s good to see an immediate disaster has been averted.



But, this correction, unlike past ones during this 2009-15 bull market, has the potential to run a lot farther. Since 2012, almost all the falls in the market have been caused by lightweight transitory matters.

Be it Greece (over and over), the debt ceiling, or the Ebola threat, the market kept dropping on fairly unimportant causes. Greece’s GDP is smaller than many US states’ GDPs, its failure simply isn’t broadly significant to world markets in general, or the US in particular. The debt ceiling panics have had an artificial air to them, completely avoidable problems caused by political grandstanding rather than anything substantial. And the market plunged on the threat of Ebola though it never it even arrived to the US. Just silly.



The current correction is, by contrast, based on concerns that come from a much deeper root. China is the world’s second biggest economy, and one of the US’ key trade partners. More than that, as the predominant source of rapid growth in the sluggish post-2009 world economy, China has literally been the marginal bid for just about everything, from US treasury bonds to copper and grain stocks.

Now that China has seen its market crash and its economic growth stall out, the ramifications have been immense. Sure oil has crashed, that’s important and one key effect. But it’s not just oil: gold, copper, food commodities, US treasuries, steel, China has stopped buying, and in many cases is actively unloading these assets. Commodity indices are close to 15 year lows now in the wake of the unrelenting oversupply.

The damage has been enormous. All the countries that had been growing by supplying China are facing severe economic strain. Developed powers like Canada and Australia have seen their currencies devalued 30% seemingly overnight. And the previously overheated housing markets in both countries now are heading downhill rapidly, threatening to set off another 2008-style real estate driven bad loan contagion.



And in emerging markets, things are even worse. Countries that rely on selling oil and minerals have come totally unglued. Just look at markets like Peru and Colombia, which are down more than 50% and 70% off recent highs. Emerging market currencies are breaking left and right, from Kazahkstan to Argentina, Turkey to Russia, emerging market currencies are straight-on collapsing.

For these countries, which often have substantial debt loads payable in dollars, the budgetary pressure is dramatic. We appear to be heading toward a major emerging markets debt crisis. Unlike Greece, US banks are very much exposed to this now-toxic paper.

The closest parallel to our current market appears to be 1998. In that year, Russia blew up, unexpectedly defaulting on its debt and causing hedge funds to collapse stateside. The US market fell 20% over the course of a month or so, with a 6% one day plunge to (seemingly) finish the selling. The market rebounded strongly the next day, and folks started to relax.

The market then rattled around for a month, trading up as much as 10% at one point, but continued to whipsaw. After that month, the market dove again, taking out the previous low by a small amount. Many investors who held or bought near the first low got shaken out by the subsequent further decline. The market then turned solidly higher and resumed rallying into the end of the year.

If we follow that model, things will turn out alright. 1999 ended up being one of the best years in stock market history, particularly if you were involved in the final stage of the internet stock run up. Could 2016 be 1999 again? Sure it could, now, like in 1998, we were in the late stages of an old bull market. Shares were already overvalued in 1998, as they are now. And biotech now, like the internet then, was a hot sector already well into bubble stage valuations.

If this is 1998 all over again, a sudden global panic caused by fears of worldwide economic slowdown and emerging market defaults, then we have more volatility ahead of us. Investors buying now will make out alright, but with more heartburn to come. Unlike the, say, 2021 Ebola correction, this selloff has a good catalyst that’s caused it, and it’s unlikely the market will make a ““V”” and go straight back to the highs.

There’s nothing to indicate we are going into a bear market now either, but this dip seems different from previous ones in this bull market. Play safe and don’t trade with too much margin/aggression. Be careful out there, the wild volatility of the last few days probably isn’t quite over yet.

Increased deflation risks may push Central Banks for more action

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September 26, 2021
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This morning, executive Board Member Peter Praet of the European Central Bank (ECB) said that current developments might lead to additional measures. Mr. Praet, who also as the Chief Economist of the ECB, sees a risk in the weaker developments in the world economy and the continuing fall of commodity prices. These developments have the potential to disturb the ECB’s policies in achieving its inflation target of 2%.

ECB ‘Ready to act”

Interestingly, Praet also connected the recent developments with the ECB’s  current QE-program and that the institution could make adjustments in the program. He said: ”There should be no ambiguity on the willingness and ability of the governing council to act if needed “ and continued “The PSPP (public sector purchase programme) provides sufficient flexibility to do so in terms of size, composition and length of the programme.” (source: Reuters) This is highly remarkable, since a number of developments in the Eurozone seem to indicate that PSPP is working. Expanding the program wouldn’t make sense at this moment in time. We could regard Praet’s words as a strong verbal intervention. However, we should note that Praet is regarded as a strong indicator of the ideas within the ECB’s Governing Council (GC). The next monitory policy meeting of the GC will be on September 3. For now, it seems too soon to expect that ECB will decide during this meeting for an adjustment in its QE-program. Nevertheless, investors should closely follow the press conference after the meeting.

What will the Fed do?

The current turmoil, ignited by China’s removal of the Yuan-peg, puts the Federal Reserve in a difficult spot. The decision by the Peoples Bank of China (PBoC) has the potential to cause new deflationary pressure, due to a weaker currency and thus cheaper exports to Chinese trade partners. In addition, it underlines the weakness of China’s economy. Earlier this week, PBoC also cut its interest rates. Globally, the US Dollar becomes once more stronger by the day, fueling further deflationary risks. On the other hand, the US economy seems in reasonable shape, as shown in this Wednesday’s durable goods-figures. In July, durable goods rose a season-adjusted 2.0% MoM, more than expected (-0.4%). Core durable goods rose 0.6% MoM, and thus came in above expectations (+0.3%) as well. As we all know, the Fed’s mandate of maximum employment is close in being achieved. So domestic economic developments don’t put a potential rate hike in danger.

However, let’s regard the issue from another dimension without looking at current rates. With the current inflation of significantly below 2% and a threat of fresh deflationary pressure, would this warrant a rate hike? No, certainly not. One could argue this would even warrant a rate cut! Back to reality, this line of thought may show that a rate hike is certainly far from being a done deal (or even a close call!).

All eyes on Jackson Hole

This Thursday, Friday and Saturday, central bankers will gather in the annual Jackson Hole Symposium. Fed’s Chairwoman Yellen will not attend this year, but Vice chairman Fischer will, as well as Bank of England Governor Carney and Vice-President Constancio of the ECB. We can expect a number of headlines coming from this retreat in Wyoming. But headlines quoting Fischer will be the most important. Will he be more dovish than his recent remarks in a Bloomberg-interview where he pointed to the split in results in the Fed’s dual mandate? Also comments regarding market volatility will be closely watched. Fed member Powell indicated in a recent speech that the Federal Open Market Committee carefully considers  its decisions to prevent taking the markets by surprise. The next FOMC meeting is scheduled at September 16-17, followed by a press conference on the 17th. The Jackson Hole symposium seems like the right moment to bring more clarity about whether or not we should expect a rate hike in September. Once again, the central stage is for the Central Bankers these days…

Another Rough Day For The Markets: Now What?

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September 26, 2021
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Monday seemed like it could have been a reversal day. After a big drop Thursday and a bigger drop Friday, stocks reversed hard on Monday. Sure, shares weren’t exactly higher on Monday, but they did post a solid recovery off the 1,000+ Dow drop in the morning. A -600 close wasn’t good, but it was a 50% recovery off the worse levels of the day. Adding to that…

The Dow opened up 400 and traded around there much of the day Tuesday, causing many investors to think the worst of this crisis had passed. After spending nearly all of the day up in this lofty range around 300-400+ on the Dow, shares started to sink around 3pm ET.

And then, they started to really plunge. Within an hour, all the gains of the day would be wiped out. The Dow, which had just recently been +400 found itself down more than 200 for the day. That’s right, shares utterly wiped out, dropping 600 big on

Yes in the pivotal final hour.

So what to do now? Is this the moment to throw in the towel to sell it all before things get even worse?

First off, why’d we crash at the end of the day? There’s no clear reason. There weren’t any foreign markets that collapsed in that span, and crude oil was well behaved. Nor were there any particular large-cap stocks leading the dive.

Yes, it does appear this 600 point rapid final-minutes Dow plunge was the work of unthinking computers rather than anything logical or explicable. So, if we dropped without a reason, should we be buying tomorrow?

Yes, probably, but it’s complicated. If you’re trading with a very short-term outlook, let’s say three days or less, then I can’t help you. The market may rocket, it may nosedive, or it could do a bunch of nothing tomorrow. Anyone promising to tell you what will happen on a short term basis is misleading you.

On a longer term outlook, yes, the market probably isn’t a bad buy here. To be clear, no the market isn’t “cheap” as value investors define it. The normalized PE is still well above “bargain basement” levels.

However, depending on the index, the US is down close to 15% over the last week. We’re way oversold, and a big huge bounce should come soon. Whether or not you think prices head lower into the holiday scene is hardly relevant.

The thing is, with shares down this hard, a bounce is nearly inevitable, regardless of the state of the broader economy. After plunges this big over the last thirty years, a big short-term recovery is almost inevitable.

Whether or not it sticks for the longer term is a different question. There were big bounces in 2000, 2007, and 2011. Given those economy crises, we know how those turned out.

Regardless, in general (and yes, this is general, this isn’t specific advice to buy or sell a security!) we feel that we’ve reached an attractive level here at sub-1900 S&P 500.

Could things go lower? You betcha, absolutely. Is it likely? No, no it isn’t. In fact, after the biggest one-day VIX spikes in history, returns are usually fantastic for stock buyers. According to that chart, a vast majority of buyers will enjoy a positive return 1, 3, and 5 days after a crash incident.

Since both Friday and Mondays were “crashes” according to that standard, we should be well primed for the inevitable recovery afterwards.

What are we to do? For one, you need to reconsider your portfolio allocation. If you are having trouble sleeping tonight, or you’ve had nightmares recently, you should probably sell some positions. Your health is more important than your net worth; pare your assets down to a level where they don’t cause you to lose sleep.

So yeah, if you’re already nervous, this isn’t the point to be trying to buy more. That said, don’t sell anything! Retail investors – smaller players – are famous for underperforming the market as a whole because they puke up their shares to the bigger boys during these sorts of market routs. I entreat you, don’t be that guy who sells out at the bottom.

If you’re feeling good about your position and asking how you can take advantage of the current downdraft – then yes, this is the time to be buying. What to buy? You can target particularly oversold stocks – there’s plenty of stuff down 20% or more over the last week.

On the other hand, you can buy your favorite stocks at a good price. They may not be smashed exactly, but the big-cap market leaders like Apple (AAPL) have indeed dropped far off their highs in recent days.

Regardless of what you do, the important thing is not to sell. If you own a well-diversified portfolio, you probably own mulitple stocks down 20-30%, if not more. And yes, it feels terrible! But don’s sell, things will improve.

Why ETFs Are Tricky In Times Of Turmoil

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September 25, 2021
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A large part of today’s money is invested in actively managed mutual funds or passive funds, known as Exchange Traded Funds (ETFs). In the recent years, in particular these ETF’s have made a stellar growth and are part of many investment portfolio and 401k’s. The 3 most liquid ETF’s have a combined Net Asset Value of USD 225bn. As such, these instruments play a significant role in the investment flows. This was underlined by recent developments, especially the early morning rout we witnessed this Monday.

Tracking the market

ETFs are a major driver of market direction. For example, when there are a lot of investments (‘inflow’) in an ETF, this fund has to invest these funds in the market. Its mandate obliges the ETF to be fully invested to be able to track the movements of the underlying as close as possible. As a result, for example an ETF which tracks an index, has to buy shares pro rato in the underlying index. On the other side, when a large number of investors are selling their ETF, the fund sees outflow and has to sell its underlying shares (see figure 1).

teuscherfifthavenue.com

Reinforcing market movements

The dynamics of inflows and outflows have the potential to reinforce market movements. In upward trending markets, this is most of the time a steady process. As the saying goes, markets take the stairs up and the elevator down. When everybody wants to exit, things can get nasty with the ETF dynamics. A recent article in the WSJ pointed out to the fact that volume on stock markets tend to concentrate in the first 30 and last 60 minutes of the regular trading hours (i.e. 9.30 – 10.00 am EST and 15.30-16.00). This is also the time of day ETF’s are balancing their assets, based on the flows of the day. So in case investors turn bearish and are heading for the exit in the early phase of trading, matching of supply and demand will disrupt. This is what we saw yesterday at opening: since everybody is selling, ETFs and mutual funds have to join the pack, causing bizarre movements.

More ETF-driven turmoil to expect?

Although US-markets had a relative quiet first half of the year, ETFs were confronted with a steady outflow. For example, the largest and most liquid ETF, the SPDR S&P 500 ETF (SPY) saw it’s number of outstanding shares declining with roughly 20% (see chart below). The outflow implied that SPY had to sell part of its assets.

www.teuscherfifthavenue.com EFT

Investors should follow the ETF flows closely. For a part the flows are tracking the market. However, outflows indicate that money is going out of the market. Potential weakness may thus be spotted in an early phase. As for now, the trend for 2015 seems to be unfavorable. Be also prepared for extreme moves in the first 30 minutes of trading. Don’t place market orders pre-market, since these orders will be executed at very unfavorable prices. On Monday, a lot of shares and ETF’s showed abnormal price declines in the first minutes of trading, ETF’s were even traded with huge discounts to their Net Asset Value. Not soon thereafter, prices began to normalize. Don’t get caught in the wrong movement.

After the Plunge: Takeaways From The Recent Volatility

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September 25, 2021
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Last week saw the US stock market take some hits. The market was down sharply both Thursday and Friday. The continuing pressures from China’s slowdown and the continuing crunch in the energy sector finally came to a head Monday.

The stock market crashed Monday, with the Dow opening down a 1,000 points; a nearly unprecedented feat. Shares would recover, getting back to near breakeven around the lunch time, before lurching back into another nosedive at the end of the day.

It’s still too early to tell if we’re entering a new bear market or if this is another passing correction. Will this be another quick scare like the Ebola panic of October 2014, or is this the real deal selloff bears have been yearning for? Time will tell.

What we can take away from this has more to do with the specific market troubles this morning. The most important takeaway is that the market is still fragile, in fact, perhaps more fragile than it was in 2008.

Through lunch-time, before the market plunged again, it appeared we’d been victims of a flash crash in the morning. The sudden dumping of stocks into a bidless market really felt like some sort of high-frequency algo sequence gone bad. Were actual humans choosing to puke up stocks in the morning at such crazy prices?

Just to name a few, Baidu (BIDU), China’s $50bn internet giant found itself down more than 30% this morning. Baidu, which traded at $220 as recently as a month ago closed Friday at $150. Today, it opened way down and soon plunged to precisely $100.00 even, where it then turned on a dime and headed $40 back up an hour later.

Apple (AAPL) similarly crashed, falling as low as $92 before rebounding nearly 20% later in the day. That’s just crazy! The world’s largest company just shouldn’t see its value fluctuate anywhere nearly that much.

Other notable names included hospital operator HCA that plunged 50% in the morning, losing $30bn in value before recovering most of its losses. Mundane toothpaste seller Colgate (CL) saw shares decay 20% in mere moments. The US’ arguably leading biotech firm, Gilead (GILD) also enjoyed an inexplicable 20% collapse.

Things were equally bad, if not worse, in the ETF space. Rather vanilla theoretically low-risk ETFs such as SPDR Dividend ETF (SDY) collapsed more than 40%. Its underlying holdings weren’t down nearly that badly, but the algos got out of control and started dumping shares and hitting stop losses into a bidless vacuum.

Similarly, the S&P Buywrite ETF (PBP) also crashed more than 40%. Unlike SDY, there was no plausible explanation for this whatsoever. PBP simply owns the S&P 500 and sells call options against it. PBP, then, by definition is a slightly lower-risk investment that should just about track the S&P 500 tick for tick. And yet, when the S&P 500 was down less than 10%, PBP was on a nearly half-off sale. Pure lunacy.

What are we human investors to do in this computer algorithm-driven minefield? We need to have a plan in case of flash crash.

First things – it’s usually clear when there’s a high risk of flash crash. The market had been tanking for weeks before the big crashes started in 1929, 1987, 2000, and 2008. Even before the May 2010 flash crash, which wasn’t part of a big correction or wider economic problem, there was a solid 4% multi-day drop setting the stage for the ultimate washout.

Similarly, the large dives Thursday and Friday made it clear we were in the danger zone for a Monday nosedive. Once we were at risk of flash crash, that’s the time to consider your reaction in advance.

When you know that there’s a risk of flash crash, it’s a good time to reconsider your portfolio holdings. If you are on the fence about something, consider selling it before it potentially crashes. Better to make that decision calmly, not when you’re staring at a miserable 20% spike down on your screen.

On the flip side, consider which holdings you like most. What would you want to own more of? When Apple is at, say, 105, ask yourself, would I want to own more of this if it suddenly collapsed 10%? Set a limit order at 95, and boom, you got an awesome buy Monday morning.

Many people say it was hard to get fills buying stocks that were way down Monday morning. The people who did get the best order fulfillment were the people who had preexisting sitting buy orders on set prices. If the market trades below your limit, they have to fill you. If you’re trying to buy with the market constantly halting, unhalting, and gyrating, it is much harder to get an actual buy order concluded.

Put your buy order for Apple down 10%, Colgate down 10%, Baidu down 20%, and so on. If they hit, awesome, you got a steal and can either hold them or flip it hours later for some fast money. If the orders don’t fill, no cost to you.

And if you see ETFs that are trading below any logical price, as the dividend and S&P buywrite ETFs did this morning, buy a small amount and flip it later once the algos start pricing it right again. Just make sure you understand what’s actually in the ETF before you get into it.

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