Category: Finance

Finance and Economics related articles

Markets are lulling people into a false sense of security

Been busy looking at various securities (trying to pick the entrails of the crash earlier this February), but still haven’t found anything too compelling. I will especially note on the fixed income side of things there appears to be a lot of traps hiding (similar to Toys R Us unsecured debt last year went from 90 cents on the dollar to 20 cents in about a week). Want another value trap? Here is another.

I’m going to warn readers that things may be quite boring for the next little while. Investing right now seems to be a matter of forcing money to work and that is a recipe for losing it. So I’m continuing to wait.

One last observation:

Do you think this is the market trying to lull people into a false sense of security? Convincing people that the mini-crash we had in early February 2018 was just some sort of aberration due to the overwhelming amount of money betting against volatility?

Instead, people should be paying attention to this chart:

The trajectory here, if the last six months is repeated in the next six months, should frighten people. Coupled with the reverse of quantitative easing eating away at the general liquidity of the marketplace (move the slider on the bottom of the chart to show 2017-01 and beyond), is a recipe for asset price compression. Almost everybody of my generation has only seen rock-bottom interest rates and loose monetary policy during their adult lives. Adjusting to a culture where interest rates are not zero may take some getting used to.

State of the overall markets – suggestions needed

The S&P 500 is now down 3.5% year-to-date, while just last week I was writing about how it was up 7.4%. This, my friends, is over a 10% drop in the market in just 9 trading days. Incredible.

There will be a bit more vomiting but things will stabilize once all of the volatility-linked financial instruments continue their algorithmic unwinding. There has been a surprising lack of candidates out there that appear to me to be obvious victims of margin liquidations (unless if you so happened to own XIV!).

Yield-based financial instruments (prefereds, corporate debt) appear to be doing just fine. REITs have shown weakness, but probably due to markets pricing in the increasing rate environment. The Canadian markets haven’t been disproportionately affected – probably because the Canadian markets were never up that big to begin with. I’ve only seen significant damage in fossil fuel companies, but for obvious reasons (the federal and provincial governments are trying everything possible to kill the sector).

One of my talents that sets me apart from most others is my ability to side-step market crashes. I’ve done it in my very early years of investing in 2000, I did so in 2007-2008, 2016, and this week. I’ve had a few false alarms (I am financially paranoid), so I am not claiming perfection. Normally when circumstances become so obvious to invest (like it was in the first quarter of 2016), I do so, and go on margin. Right now, I’m roughly at 30% cash.

I’ve been trying to figure out how to deploy cash. One would think that a 10% market crash in two weeks would unearth some opportunities. If I find things exceptionally cheap, I have no problems dipping 10, 15 or even 20% in margin depending on the valuation parameters. But it’s nowhere close to doing this.

Something I’ve found very frustrating is there’s still nothing on the radar that has really attracted my visceral instincts.

I’d appreciate some suggestions.

Volatility

I thought my previous posts about raising cash were correct, but I wasn’t expecting it to be that correct.

Picking through the entrails of this mini-crash, I actually don’t see much signs of margin liquidation – this was an old-fashioned concurrent stampede of trading that wanted to get out all at the same time, and they did it with the high-capitalization stocks.

I didn’t see much of an effect on the Canadian market. Normally there is a bit more correlation. I’d expect to see smaller, less liquid issues being sold off as people panic to sell anything to raise capital.

Something else odd was that normally when the market crashes like this, the 30-year treasury bond yield drops a lot, but like the past week, the equity and bond prices (not price-to-yield) are correlated.

This is one of the oddest high-volatility periods I’ve witnessed. It reminds me of the spring of the year 2000. Normally I should be deploying capital when the volatility index is high, but this is a one-day spike and it is nothing sustained. I would not be surprised at all to see a huge rally up followed by another gut-wrenching crash later.

I already have a list of stocks assembled for purchase if the price is right, but currently, the price is not right.

With the decline of the Canadian dollar, my portfolio (as measured in Canadian dollars) actually rose on Monday.

Finally, the S&P 500 at 2648 means that it is down for the year. I’m finally outperforming again.

S&P 500 year to date

Caution investors – if your portfolio hasn’t risen +7.4% since the beginning of this year, you are underperforming! (Just for disclosure, I am underperforming the S&P 500 year to date!).

I’ve attached the above chart to show how parabolic things are going to get over the next little while.

I can just imagine clients telling their value managers about how much their friends are making on cryptocurrencies, marijuana, and also by people just dumping money in the top 10 large-cap companies, irrespective of any fundamental underpinnings of these corporations.

There are times in financial history where this has occurred before. I’m thinking 1999 or early 2000. It doesn’t end very well.

Raise cash. It is the most difficult trade to hold cash right now – precisely why it is correct.