02 Mar LAST WEEK WAS ONE FOR THE RECORD BOOKS
As widely discussed, last week was one for the record books…the fastest correction ever because of the coronavirus. Indices were down about 11%-12% last week and off about 14% from their apex.
Some will write the massive selloff is partially the result of a near manic environment that pushed valuations in some sectors to unsustainable and unrealistic heights. Others will opine the selloff is partially the result of broken trading mechanics, the ramifications of the total domination of technology based and passive trading strategies. Others will state it is nothing other than noise.
Two weeks ago, the “FOMO” phrase was widely discussed.
I nor do anyone else have any idea where the markets will bottom. With this written, when the attitude is sell at any cost, a major bottom is at hand. An argument can be made that such was the case Friday for the energy sector and consumer nondurables. Energy was actually up.
I think the markets have not yet faced its greatest issue, an issue that was magnified last week.
I am a collector of magazines, research reports and newspapers. I keep a copy of the October 16, 1987 Donaldson Lufkin & Jenerett weekly research booklet in my desk. On that Friday, the research firm opined that in short order shares will revisit their August 1987 highs and the increase in interest rates are unsustainable. [Note: I had entered the brokerage business in December 1986]
As history states Monday October 19, 1987 the Dow plummeted 22.4%, the result of higher interest rates, portfolio insurance and technology-based trading. Yes Virginia the Fed did lower rates that day but higher interest rates were regarded as a major factor for that record plunge.
Fast forward to today. Since February 1 Treasury yields have plunged, primarily the result of technology-based trading. I ask what happens when yields reverse themselves from these incredibly low levels?
Contrary to popular opinion, interest rates are a major determinate of stock market direction. The bond market is substantially larger and more influential than the equity markets.
All know the catalyst for the recent plunge in both equity prices and bond yields…the coronavirus and the absolute hype and mania surrounding the apocalyptic outcome. What happens if this outcome does not unfold?
Morgan Stanley joined Credit Suisse in stating the damage from the coronavirus is temporary and global growth will bounce back later in the year, perhaps at levels that generate inflationary pressures.
Every sell off since 2010 was the result of higher interest rates. I would like to focus on the three most recent selloffs…February 2018, December 2018 and September 2019. During the 2018 episodes, economic activity rose by an amount greater than expected that impacted monetary policy views that created great uncertainty in a popular Treasury carry trade that impacted equity prices.
The 2019 episode was the result of an unexpected change in Treasury yields that also imploded a similar carry trade which in turn crushed the repo market. The Fed stepped in and provided liquidity and equities surged partially the result of central bank intervention.
What happens if the apocalyptic outcome does not occur and both Morgan Stanley and Credit Suisse are correct? As noted above the bond market is a primary determinate of equity direction and is significantly larger than the equity market.
Are these meaningless and rambling thoughts?
Two weeks ago, the term “FOMO” was the rage. Trading volumes at the deep discount brokerage firms were double than they were six months ago. I think most have not yet realized the carnage that has occurred, a carnage that will be brought to reality shortly via their monthly statements, a point amplified given the Dow closed at close at an eight month low on the last trading day of the month.
What will happen this week?
The economic calendar is comprised of many top tier statistics including the ISM Manufacturing and Non-Manufacturing Indices, various employment statistics culminating in Friday’s release of the BLS Employment report. I think most will disregard the data, defining it as pre-corona and essentially meaningless.
This is a dangerous position to take for no one knows the path of the virus. What happens if the hysteria is unfounded?
Last night the foreign markets were mixed. London was down 0.60%, Paris down 1.63% and Frankfurt down 1.70%. China was up 3.15%, Japan up 0.95% and Hang Sang up 062%.
The Dow should open moderately lower. Futures have been extremely volatile this morning on rapidly changing views of the possible outcomes of the coronavirus. The 10-year is up 29/32 to yield 1.06%