“Risk happens slowly, and then all at once….” Keith McCullough, CEO Hedgeye Risk Management
Just over two weeks ago, equity markets traded at all-time highs. The banter on most financial news outlets was anything but cautionary…
I recall a day just before the sell-off began when I had, for the first time in a long time, un-muted CNBC at lunchtime to pause and listen to a panel of traders and “experts.” “This market is bulletproof!” was the consensus. I remember pausing for a beat and thinking to myself, “Wow, this is about the time the ‘stuff’ hits the fan.” Granted, at that point, the stock market was not yet reacting to Coronavirus, and the word “pandemic” was hardly being uttered. Nonetheless, to me it just seemed like irresponsible messaging to the investing public. Especially considering the economy showed signs of slowing for the better part of five calendar quarters. It just so happens that the market caught the “virus” before it caught a cold from what was likely more data confirming ongoing economic slowdown.
Here’s what we knew leading up to this correction: the investment world (hedge funds, institutional investment firms, etc.) was highly leveraged into the equity markets and positioned with the expectation that more all-time highs were in the works. Without getting too technical, it is possible to see how the market is hedging and/or leveraging with futures and options contracts by examining published reports provided by the CFTC (Commodity Futures Trading Commission). When the pendulum swings hard to one side (in this case, bullish), and the market experiences a shock like the Coronavirus, the pendulum swings hard in the opposite direction. The intensity of the volatility is often driven by computer-based algorithmic trading programs.
An algorithm is a set of defined rules designed to carry out a certain process; thus, algorithmic trading uses computer programs to trade at high speeds and volume based on preset criteria, such as stock prices and specific market conditions.
Hedge funds and institutional-level investment firms often set parameters for exiting positions to de-risk portfolios in times of market downturn. For example, when the market sells off by “x” percent, their computer algorithm says sell “x,” and market orders start flowing.
In today’s world, over eighty percent of all market trading volume originates from computer-based programs. When the “machines” say sell, the volume of sell trade orders spikes, and we witness indices like the Dow Jones Industrial Average, S&P 500, and NASDAQ swing violently during the trading day.
What happens next is impossible to predict.
The Merriam-Webster Online Dictionary defines the word “conjecture” as “an inference formed without proof or sufficient evidence, and/or a conclusion deduced by surmise or guesswork.” I don’t know how the Coronavirus scare will resolve itself; but, I do know that the speculation on how much it impacts the markets, how far the indices will fall, and when investors should “buy the dip” is all conjecture. I’m not going there. The highest probability outcome is that this will get worse before it gets better; but it will also end at some point, and life will go back to normal. Expect a negative impact on global economic growth and corporate earnings, and realize the magnitude of impact will depend on the duration of the virus spreading and volume of those infected. This likely won’t be like the short-duration “V”-shaped market recovery we saw in late 2018 and early 2019.
Be patient. Don’t panic.
In my opinion, it is not yet time to buy the dips. If you need income from your investments in the next 12-18 months, let’s connect about your portfolio cash levels and plan accordingly. If you have an extended time horizon before needing invested funds, turn off the financial news and don’t look at your statements for a while. Wash your hands, clean your cell phones, water bottles, car keys, steering wheel, door handles, and keep your hands away from your mouth, nose and eyes.
You’re likely never contracting Coronavirus, and this will at least keep you from catching a cold. Be well!
Until next time,
MM
