I last wrote a blog six days ago, on March 12. Now, at March 18, we can more clearly see some important facets of the current financial stresses. First I will outline some of those stresses, and then I will discuss what I think may unfold over the rest of 2020.
We have a fragile financial system, much more fragile than our economy.
Stock market volatility, measured by something called VIX, hit a record high on March 16, even higher than it hit in 2008. What’s more remarkable is how long the VIX has been high and has stayed high. That’s unique, and has to be really hard on trend following (e.g., momentum) investors and risk-parity funds (quantitative leveraged hedge funds that follow rules where, as VIX goes up, they need to sell assets to reduce portfolio risk). The bright side of current VIX is that you’d like to think the odds of VIX relaxing for a while are high, at least based on history. That would help support a rally. But right now, one day the market loves risk; the next day the market hates risk, so VIX remains high.
A broader problem is numerous signs of dollar funding stress. Banks and other financial players are looking like they prefer cash to holding any “risk” asset – not only stocks but even U.S. Treasurys. Someone has to hold those risk assets and it looks like the Fed is stepping in to backstop the holders. In my March 12 blog I talked about the Fed making TRILLIONS of dollars available in the repo markets. That hasn’t helped. On March 17 the Fed announced that they will open a commercial paper purchase program, where they will purchase 90-day corporate commercial paper from dealers and directly from corporate issuers. The Fed has also broadened its Quantitative Easing, asset purchase, program. And the beat goes on.
In addition to all the varieties of Fed monetary supports of financial markets, now we are seeing Congress discussing lots of different plans for fiscal stimulus, and the fighting over the largesse has begun. Based on history, I expect a lot of pork for friends of politicians. You’d like to think something would be finalized soon.
Turning to the economy, consumers and the economy do not appear to be as panicked as the financial markets. Retail sales slowed more than expected, but weren’t that bad. But there’s a lot of speculation about what March retail sales numbers will look like. Overall, small and medium sized businesses are saying sales are down.
Of course, everyone expects a slowdown. The question is how deep and how long. Most people seem to be expecting a short, sharp slowdown with a recovery in the second half of 2020. That seems a bit optimistic to me. My attitude is all these government stimulus plans have a short-term positive effect, then there are just too many unresolved problems. Massive debts; compromised supply chains; evidence of coming recessions around the world; etc. If central bank and government stimulus worked long-term, Europe and Japan would be Shangri-La’s.
The impact of an economic downturn on food and utility stocks should be pretty small, and energy and financial stocks are already priced for death. Most of the rest of the market looks broadly dangerous to me. Thus, that’s how we’re broadly positioned, with a plan to focus more on safety after the market starts breathing again.
One other thing I want to keep repeating is that stock market pricing is very unstable. To some extent, thank the pork from our last big financial crisis, which replaced a perfectly fine stock trading system with HFT (High Frequency Trading), which is more focused on stealing pennies from you on every trade than on providing actual liquidity – trading volume around current prices. In my mind, HFT has helped break the current market. I’ve never seen so many wild price swings across so many assets, even Treasurys. As such, you really have to take the prices you’re seeing with a grain of salt. They have often changed wildly, both from day-to-day and even intraday, and that may continue. Honestly, if your job isn’t dependent on dealing with financial markets right now, it’s probably better to do something else rather than watch this craziness.
We hope to see some relative market calmness appearing on the horizon, as the economic situation and government plans become a bit clearer. Based on history, we could see a market bounce, quite possibly a rotation away from growth and toward value, and a repricing of market risk as the economy moves forward at no better than a shambling pace, regardless of the volume of Congressional fiscal stimulus (pork) and Fed monetary supports (bailouts).
Most of the stocks out there have a value, and I believe a number of them may be trading below that value right now. Our job is to find those stocks and be involved in them. Even if they decline over a week or month, the point is to be sensibly positioned over time. And so, I am thinking more about what the markets and economy may look like at the end of the year than the end of the day.
This is enough for now. I will be back.