Once again, we experienced a 1000+ point move in the Dow Industrials. It was the sixth straight day of 1000+ moves. After Monday’s historic 3000-point loss, yesterday’s gain hardly felt overwhelmingly positive. We have now had over ten 1000-point daily moves in the market over the past four weeks. Today, 1000-point moves equate to about 5%. There have been years when daily moves never even exceeded 5%. Futures once again predict yet another 1000-point day today, this time down once again. What gives?
Obviously, the coronavirus and the escalating economic threat has been the catalyst. But in bear market moves, when volatility spikes, computer trading moves from the background to total domination. While algorithmic traders insist they don’t accelerate market movements and they add liquidity, every morsel of evidence strongly supports the opposite. They accelerate volatility and reduce liquidity. Spreads, even for ETF trades, have widened materially. During the financial crisis, realizing how these traders accelerated volatility, the SEC moved to limit short selling. Since then, the passage of Dodd-Frank, which eliminated proprietary trading by most large Wall Street firms, the elimination of specialists, and the rules that short sales could only be executed on upticks have been eliminated. As a result, as we witnessed in early 2018 and now, with an exclamation point in 2020, the absence of safety barriers means that computerized trading now dominates markets.
There is an indication called VIX, a measure of volatility linked to option premiums. It crossed 80 for the one and only time in 2008. Normal is 10-20. This week it crossed 80 once again. Even after yesterday’s rally, it fell below 75 but it will surely spike upward again this morning. What that means is that, day by day, you can throw out almost any fundamental explanation for market movements. When the Fed cut rates by 75 basis points over the weekend, it simply didn’t matter. Momentum driven computer trading models read “sell” on Monday. Markets fell 2800 points at the open, moved around over 7000 points during the day, and ended down almost 3000 points. Yesterday, markets reversed and recovered 1000 points, on no news. As noted, overnight, the gains have been reversed once again.
Clearly there are fundamental reasons for the decline as well. Liquidity is a huge issue. The Fed is doing all it can. Primary market makers, the largest banks, can now take almost any asset to the Fed window and convert it to cash. The twin problem is to get cash into the hands of small businesses and individuals most impacted by nationwide closures. That means owners and employees of thousands of restaurants and small retail stores now shuttered for at least the next two weeks and maybe longer. While the Fed can put the money into banks, much more action is required of Congress and the White House. Both are beginning to realize the scope of the problem. But both have been behind the curve. Without being critical, events have been moving so fast neither is set to act as quickly as the real world is evolving. That doesn’t mean they won’t catch up. But until investors can see the other side, without overwhelming carnage, markets will remain in turmoil.
Yesterday, for the first time in several weeks, markets seemed to separate winners and losers. Consumer staple companies, utilities, technology enterprises, and health care all had robust days, while energy, banks, home builders, and leisure-related companies kept going down. Not all the “losers’ are headed to zero, but until it can be demonstrated that they have an ability to get to the other side when business starts again, their stocks will be collective pariahs. That is not to say that some of the losers won’t morph into the biggest percentage-winners long term. But right now, they have to be avoided. That isn’t where risk money is going to start to flow. Their time may come but it won’t be for a while.
The elevated fix guarantees herky-jerky markets until (1) there are signs the virus is peaking, and (2) there are indications that governments have the economic backs of people and companies most affected by the necessary public health shutdowns. Neither is in place yet. With that said, if there was anything positive to say about yesterday’s market, it is that the market, for the first time in weeks, tried to separate the wheat from the chaff. It identified a group of companies that will make it through much less wounded than those at the eye of the storm. These might include consumer staples companies like Procter & Gamble#, Clorox, Colgate# and Kimberly Clark. It includes utilities, health care companies, especially those involved in treating or curing the virus, and technology companies where working remotely has always been common practice. It includes retailers that must remain open for society to function, like grocers and drug stores. At the same time, despite the market’s overall 4% gain, the losers went down further, led by energy, hotels, airlines and homebuilders. Not too many open houses scheduled this weekend. That doesn’t mean the losers will all die. With low interest rates, once the crisis ends, people will find real bargains out there. But not now.
Markets today are overwhelmed. Volatility interferes, but it is also a symptom of the one-way rush to safer havens. However, when everyone wants to be on the same side of the trade, markets stop functioning properly. Treasury yields are rising, almost counterintuitive to what one might expect if everyone wants to buy Treasuries. Logic suggests Treasury prices should go up and yields down. Some believe the computer traders are making money hand over fist here. But when markets become so erratic, spreads widen, and the ability to get in and out is impaired, they often fail as well. There was one notable fund closure yesterday and there are more to come. Algorithmic traders all know that when volatility spikes too far too fast, the proper step is to reduce risk and position sizes. But when everyone wants to sell simultaneously, they can’t get out. That is why all asset prices are falling at the same time, why even Treasury yields are rising. Fast traders are unwinding. The net result is reflected in the downward spiral of markets. Until the process is complete, and no one knows when, the Fed must stand ready to back up markets, to keep the wheels turning. That is exactly what it is trying to do with new liquidity measures announced almost daily. The rush for cash and the rush to deleverage is overwhelming the fundamental story. That will end soon but no one knows exactly when. What we see is that every market respite, like yesterday’s 1000+ point rally, is immediately followed by another wave of selling.
But while I have been discussing market mechanics more than I usually do this morning, we can’t lose sight of the market’s real fundamental focus. When will the virus itself peak? How extensive will the economic pain be? And will the Federal government ultimately put a package together that will allow small businesses and their employees to land on their feet.
History has shown countless times over the centuries that disease, not war, kills the most people and changes society the most. When European explorers came to the Western Hemisphere, over half of the indigenous population was wiped out in just a few decades by disease. Their gift in return was to transport syphilis back to Europe. Thanks to modern technology, coronavirus won’t kill half the world. But it is also clear that, until the past week, countries like ours didn’t take the virus as seriously as it should have. Everyone now is starting to catch up and public health will win in the end. But before it is over, the damage is likely to be worse and more durable than many still believe. That is one overriding reason why markets have yet to find a bottom. Markets look ahead. But there are still too many unanswered questions. However, as the virus runs its course over the next several weeks and peaks, there will be a bottom. There will be another side. The obvious survivors, in stock market terms, demonstrated yesterday that they are already probing the bottom. The rest will follow. Bottoms may often be V-shaped, but there is a process getting there. When we get to the other side, those surviving in the best shape will rally first. As cheap as the losers appear, stay away at least until they stop going down. There will be time for them as well, but later.
Today, Adam Levine is 41. Queen Latifah turns 50. Vanessa Williams is 57.
James M. Meyer, CFA 610-260-2220