In the eye of the financial storm

Unfortunately this week has been a rather busy one for myself and I have little mental time to properly do some market research even though I am getting bombarded with email alerts for low prices that have been triggered.

“V” type bottoms rarely happen in the marketplace. The only exception I can think of was the March 2009 low and that was after a protracted agony of a financial crisis.

I notice that in today’s (Wednesday’s) 5% plunge in the markets that crude oil managed to hold its ground while the indicies fell. Also, certain issues of stocks that could be considered “higher quality” were not hammered – indeed, some of them rose despite the indexes falling a significant amount.

I am expecting Thursday to be a positive market day, although I say this with the safety and comfort of seeing the S&P 500 futures up 1.7% well before the market is going to open. During financial storms, you always see sharp action in both directions as the market continues to suck in all of those that continue to try to play their risk-on and risk-off charades in a very short time frame. As long as people are still talking about which bargains to pick up in the markets, it is still not time to buy unless if you are worried about covering your short sales.

I remain mostly sheltered with a very large cash position at present.

Bank of Canada to cut interest rates?

I notice that December BAX futures are pricing in a rate decrease by the Bank of Canada to 0.5 to 0.75%:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.880 0.000 0
+ 11 SE 98.890 98.895 98.895 0.000 23059
+ 11 OC 0.000 0.000 98.865 0.000 0
+ 11 DE 99.140 99.150 99.150 0.000 50455
+ 12 MR 99.140 99.160 99.170 -0.020 32592
+ 12 JN 99.140 99.150 99.170 -0.030 17723
+ 12 SE 99.110 99.120 99.140 -0.040 6277
+ 12 DE 99.050 99.070 99.090 -0.020 1582

Indeed, the only people making any money out of the marketplace right now are those that have been holding onto long-term government bonds, an instrument that almost everybody stated couldn’t go lower in yield.

Highest volitility of the year

The VIX index (S&P 500 options implied volatility) has officially reached the highest of the year, at 40.96%:

This is still lower than the 48.2% seen during the depths of the early 2010 crisis involving Greek soverign debt. If this issue is worse than the one last year then my 40-45 VIX prediction should be elevated.

(Subsequent Update: 46.80… this can only be described as a slow-velocity market crash.)

Payment for liquidity – anatomy of a margin call

When you go to a bank and ask for their rates on 1-year GICs, you usually get two responses – the rate for the cashable GIC and the rate for a locked-in GIC. You will receive a larger rate if you are willing to commit your money for a longer time period, at the penalty of having no interest if you want early access to your cash. The rate differences can be considered a payment for liquidity.

In the stock markets today, people are paying heavily for liquidity.

As an example, one of my top holdings, Rogers Sugar (TSX: RSI), tanked in trading because somebody needed liquidity, fast:

At 9:56 (eastern), the bid/ask was already being pushed down. It was at bid/ask 4.90/4.92 and then somebody wanted to get rid of about 100,000 shares quickly. In the span of five seconds, they took down the asking price 44 cents to $4.50 and then in the course of ten seconds there were 58,190 shares traded between 4.46 and 4.90. The bulk of the trade was done at the price of $4.50 where 35,400 shares changed hands.

This is the type of trading activity that occurs when somebody is undergoing a margin liquidation. They are paying a 40 cent per share premium for the privilege of wanting cash right now.

Generally speaking if you were on the opposite ends of these types of liqudiations you will receive a very, very good price. However, the window of opportunity you actually have to react to such liquidations is very, very tiny – you had about 1 second to hit somebody’s ask at 4.50 before somebody else picked it up. This is why computer trading is so prevalent in the marketplace – they are out there looking for such prospects.

When the market needs liquidity it does not matter what the fair value of the underlying security is – it will go at whatever price others want to pay for it. This can be much lower than the existing market value or what would be a rational valuation for the underlying company.