As I write this the S&P 500 is down over 3% for the day. The TSX is down 1.4% which isn’t so bad by comparison.
An index is simply a collection of stocks. For the two indexes above, companies that have higher market capitalization are weighted high in the index. When an index gets sold off heavily, there is a high probability that the higher capitalization stocks in the index will also be sold off.
When there is heavy market volatility it is usually wise to look at what is going down by the averages, what is going down more than the average and which stocks are holding steady or even rising, especially those stocks that are not included in a major index. It gives you some hints as to which sectors are and are not popular for the day.
Institutional investors are usually required to keep specific ranges of portfolio fractions (i.e. an allocation between equities, bonds and other asset classes). Typically when broad equities drop, managers will dump bonds in order to buy equities to rebalance the portfolio.
Today, contrary to what the market has been doing a few months ago, a selloff in equities is once again correlated to an increase in risk-free bond securities – I note that the 10-year treasury bond yield is down some 70 basis points – which means that what we are seeing in the markets today is a flight to less risky positions. The yield curve continues to flatten – there is a 10 basis point difference between 2-year and 10-year treasuries now.
If equities fall enough, collateral values will also decline to the point where portfolio managers will have to liquidate assets in order to maintain sufficient collateral – i.e. a margin call situation. If enough of this happens, you will start to see significant opportunities appearing on the equity side.
It’s more probable than not that the upcoming December meeting of the Federal Reserve will be the last quarter point interest rate hike before they take an extended pause. If interest rates stop rising, then the next market focus will be back for finding yield.
Another observation is that gold is doing reasonably well. It is a shame for most investors that most gold mining companies are poorly managed.
I’ve still got a lot of dry powder in the portfolio and I’m waiting for worse times. There will be a time to pounce but not yet.
There is one other observation I will make – robo-investing and index investors that choose allocations of various low-cost ETFs are dooming themselves to sub-par returns. Every time I hear people investing in whatever index fund that pledges market diversity (e.g. VGRO is quite popular) I just think to myself if they are truly prepared to earn low single digit returns with the real risk of them seeing 25% peak-to-trough downdrafts.
It was about 10 years ago when the economic crisis was clearly in full swing – Bear Stearns went bust, Lehman Brothers went bust, and anything financial was imploding. The S&P 500 was still at around 870 at this time. It wasn’t for another 3 months before the S&P 500 reached its low (the value being “666” appropriately enough) – you would have still seen a 23% decline in value.
This time around, how much of a value loss can index investors take before the perception of an unlimited wealth creation vehicle evaporates? Today, we are at 8% below the peak of the S&P 500. Canadian investors (via the TSX) have seen a 9% drop from peak-to-trough in the index high.
“This is just another buying opportunity to buy shares cheaply”. Or is it?
As my last note, I will point out that General Electric (NYSE: GE) is down 6.66% today. How symbolic.