Author: Sacha Peter

Markets getting slammed – how to trade in a downturn

The equity markets have been getting slammed (down about 3% currently) and bond yields have correspondingly dived as people search for safety. Most notably, this is the the second spike in volatility in the year – the first one was in March (which was caused by the Japanese earthquake).

When the bottom is in will be when the least number of people think so, but the tone of the markets at present are quite panicky – even the commodity markets are dropping in price. My guess is that this will occur when volatility reaches around 30-35.

Suffice to say when prices drop, equities become more attractive. The trade that makes money is moving from low risk to high risk when others are running away from high risk. Risk is being discarded quite actively.

Government Bond yields have dropped significantly

The one impact of the US debt ceiling extension has been that government bond yields have dropped significantly over the past week. For instance, the 10-year Canadian government bond benchmark has lost about 25 basis points which is a huge drop:

10-year bond yields are now lower now than they have been since January 2009 (the depths of the financial crisis). The bond markets are highly pessimistic about any form of economic recovery and are trading as such.

Short term rates are no longer pricing in a sure chance of a rate increase – BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.670 0.000 0
+ 11 SE 98.685 98.690 98.685 0.000 23202
+ 11 OC 0.000 0.000 98.655 0.000 0
+ 11 DE 98.660 98.670 98.660 0.010 42832
+ 12 MR 98.630 98.640 98.610 0.020 35992
+ 12 JN 98.590 98.610 98.560 0.040 16408
+ 12 SE 98.550 98.570 98.510 0.050 7649
+ 12 DE 98.500 98.510 98.450 0.060 2729

The December BAX Futures are at 98.66 (1.34%) compared to 98.46 (1.54%) when the Bank of Canada made its last pronouncement on short term rates.  It no longer appears that short term rates will be rising at all.  Three month corporate paper is still at 1.17%.  If there is any hint of economic recovery, it is not seen in the bond market.

Now that is a lot of volume

A few lines of code wrong in your database engine and you get really whacky results such as this:

I lost count after counting quadrillions. This is probably the entire float of Canadian dollars traded a trillion times in a single day!

A mental break from the markets

I have been taking a mental break from the markets and will likely continue doing so this week.

The only comment I have is that because of the US fiscal situation (which I will consider to be a crisis), companies that are highly reliant on US government revenues are getting hammered. Some of these may make viable investment candidates and would likely warrant some research attention.

Zarlink hostile takeover

Zarlink Semiconductor (TSX: ZL) is facing a hostile takeover bid. I have no idea whether investors should sell the equity or wait for something sweeter, but the relevance of this for me was that when I was looking at companies to invest in during the peak of the economic crisis, Zarlink debentures came on my radar screen. The debentures were trading at about 40 cents on the dollar back then, while the underlying company was not terribly profitable and seemed to be going along the wrong trajectory.

I was also concerned back then that you had a company which had a market capitalization that was a low fraction of the debt outstanding which would have made capitalizing the debt more difficult if the company went down that route (like Arctic Glacier, which will be condemning its unitholders to dilution purgatory at the end of July).

In retrospect, the decision to not invest was bad compared to some entities I did put my money in, but back in the middle of the economic crisis, capital was scarce and I made other investment decisions. Zarlink was a close candidate but barely did not make the cut.

Now when you look at various investments, the potential returns for risk is depressingly low. Back then you didn’t need to take much risk to get a very handsome potential reward. Today those risks are much, much higher.