Investors and algorithms can panic sell at any time and for any reason. We should expect volatility to stay high and short-term moves will stay extreme for the foreseeable future. This always happens in times of high uncertainty but remember, hurricanes don’t last very long, consumers don’t abstain from spending for long, and deep drawdowns in stocks will always be met with opportunistic buying when the fear reaches a crescendo.
Assessing today’s roller coaster headlines is amusing and confusing all at the same time. So, let’s try and make some sense out of this.
Here’s a media story from last week:
Here’s Monday’s headlines:
Thank you, CNBC, you continue to add no value to society and prefer to create panic so you can monetize more people glued to the TV. Well done.
Last week’s down move in equities was the swiftest I can remember. We saw full panic, full capitulation and a wash-out on Friday towards the close that could only be described as a full liquidation. I have been investing and trading for 27 years and capitulation leaves a footprint like few other phenomena. Capitulation feels akin to being sea-sick and in stocks, it means someone wants or needs to get out at any cost. It also usually means the rubber band has stretched so far in one direction, that a snap back is likely very soon. Enter Monday this week and the 1,000 plus point rally. Here’s some proof we saw historic capitulation selling last week. If making money investing is about buying fear and selling euphoria, I’m not sure there’s a clearer example of fear in markets than last week.
In a phrase, capitulation just means panic selling for our purposes. Capitulation is an interesting thing. Unfortunately, it’s not as simple as “when equities flush and capitulation volume arrive, buy and hold stocks, and don’t look back.” Sometimes that’s the case, December 24, 2018 is a recent example. Sometimes though, the initial capitulation is the beginning of the bottoming process. Often, markets experience heavy selling, have a few oversold bounces, re-test the recent lows, and often make new lows before a more lasting bottom can occur. The most important sign of a lasting bottom is what happens on these re-tests of the lows. Does volume accelerate or decelerate? Are there more stocks making new lows or less? What participants want to see is what we call a positive divergence. Indices make a fresh low but less stocks are making new lows than the last time the indices were at the same level. Is the VIX, the volatility index, making a new high while stocks are at the new lows or is the VIX making as lower high relative to the last high? Are small-caps confirming this new low by also making a new low or is there some strength in small-caps relative to large cap stocks? No too bottoms are the same, but these are just some of the signs I look for to help me decide where we are in the bottoming process. Remember though, this is a news driven world and algo’s, which make up 85%v of daily trading volume, thrive on headlines, good or bad.
Here’s a great chart from Canaccord Strategist, Tony Dwyer highlighting the typical bottoming process. He uses the market in 2015/2016 as the example.
News drives behavior – don’t get sucked into the media’s narrative – they are profiting on your fear.
If you are watching the news, you are being bombarded with daily virus updates and political pundits talking about who is the best person to lead the country for the next four years. You’re also being bombarded with announcements from corporations as well as the government regarding cancelling all non-essential travel and events like conferences, etc. But there’s a silver lining in the creation of consumer panic: it keeps us from more exposure to this virus. Isn’t that a good thing? Earnings will slow for a while, that is guaranteed. We have already seen a handful of companies either reduce their forward guidance for the year or reduce the next quarterly earnings projections. Supply chains in China and other countries were disrupted which lowers their GDP and consumer spending. The ripple effects are now reaching back to the countries tied to these supply chains as lower demand from slowing commerce affects businesses and inventory replenishment slows for a bit. Some commerce will just be pushed out, some will not recover. If you were planning to eat out and decided to stay home, that revenue is lost to the restaurant. But humans are not programmed to stay in their homes forever, they will stay close to home, get cabin fever, and then return to their normal lives. What is lost today, will ricochet back later in many cases. That’s not an opinion, this just reality. Yes, some businesses will suffer disproportionately, the travel industry comes to mind. A company in need of upgrading its software or implementing to the cloud may postpone the purchase, but I assure you they will not cancel the purchase forever. Deferred revenue versus lost revenue will be the norm.
I think it’s important to understand why we all seem to react to news and gossip with alarming speed these days: social media. We are a society that thrives on gossip, needs to slow down to watch the car accident, and seems to favor dark shows on Netflix versus light, funny shows like Seinfeld. A psychiatrist would have a field day with assessing the impact of social media on all our emotions.
Let’s try to dis-connect from our emotions, analyze what we are seeing, and connect a few dots to see what we should be doing and thinking now.
- We have an election in November and the candidates are slinging mud, focused on negativity and pointing fingers versus telling us what the solutions are. That causes angst and uncertainty, the market hates uncertainty which drives up volatility.
- We have the Corona Virus, Covid-19 that started in China and has now spread around the world, adding to the uncertainty and driving increased panic around the possibility of a major epidemic.
- Most important: corporations and individuals are changing behavior. They are not travelling as much, not going into crowded places for now, and generally pulling back on normal behavior.
- So, everyone now knows, for a while, commerce will be lower, consumption will be lower. When this happens GDP goes lower, companies’ lower guidance and make less money. Stocks have already begun re-pricing for this certainty. There is no rule for predicting how stocks will re-price for lower commerce ahead. Remember, stocks move because there are more buyers than sellers or the opposite. The more people panic, the more they want to sell, the more selling that happens, the more algos continue to sell, it begins to feed on itself like we saw last week.
- The Fed cut rates by 50 bps this week because there is a slowdown happening. That’s what they always do, this is not abnormal. Stocks are selling off today after the rate cut and the headline reads: “Does the government know something we don’t?” No, the government knows the economy will cool off and they do what they always do, add liquidity and other monetary/fiscal stimulus. There is no conspiracy, just the Fed and all bankers doing what they always do when confronted with slowdowns.
- There is real fear currently as measured by all popular sentiment indicators. I’ll use the CNN Fear & Greed Index, which takes several factors into consideration and displays a score of 1 to 100.
Here are some bottom-line takeaway points to consider:
- Uncertainty is high which means volatility in all markets will stay high – get used to it & take advantage of it.
- The economy will cool short-term and central bankers everywhere will continue to cut rates and inject liquidity into markets, this is not new, they always do this. Fight the Fed at your peril.
- Consumer behavior has changed while there’s uncertainty and if less people are doing the things that could potentially expose them to the virus, the result should be containment relative to the current panic we see across media outlets.
- If the virus does not spread like the markets expect (they always over-react) then the market has over-reacted and will need to re-rate higher sooner or later.
This information was produced by and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed.