Normally, I prefer to tell a story with pictures, but I’m going to try something different and bullet out 8 top of mind reasons to avoid the market. Each one could be its own blog post. Comment if want me to elaborate on any.
- Coronavirus: This should be obvious; we have a market down only 5% YTD and the best performing index in the entire world despite the highest number of deaths. Large chunks of the economy are still shutdown, and with no clear entrance plan, there is no clear exit plan. Is there really no probability of it surging again, no probability of higher taxes, etc?
- Riots: Somehow the market rose today despite riots breaking out across the country. While my primary focus is on finance, I have for years studied global peace movements (my minor in college). One thing I know from all the literature and case studies – when protests intersect with force, the situation can spiral. Now, maybe this is not a high probability event (I don’t know; it looks scary), but the probability has risen. Yet the market was up today.
- The overall market volatility has been low. However, if we look at upticks vs. downticks intraday volatility, there is clearly tension; it’s like pulling on strings. I believe there are quantitative models (CTA’s, etc.) who are buying equities on dips. They lever up intraday (sometimes as much as 15x!) to mean-revert securities and markets. It leads to a lack of price discovery and creates tail risk.
- Consumer is still under extreme pressure. Leverage has risen. Businesses are closed in large parts of the country, and there has likely been a permanent change in behavior (e.g. will people really eat out as much in the future?). Again, consumer is 70% of the economy.
- Oil has been forgotten since it bounced back from negative territory, but $35/barrel still leads to significant pressure for E&P companies; many will not survive. This bounce just extends the inevitable.
- Manufacturing is still extraordinarily weak. China had a false start in their Purchasing Managers Index, which has since faltered.
- There are wild misconceptions about how if there is monetary activity, it props up assets, and you just buy the dip. Cycles are smoothed with strong monetary policy; they come at the expense of the future (it’s like personally borrowing to smooth through a rough patch). Smoothing a global economic collapse is a different story.
- There is too much money in the system. What this whole market action tells me is there is simply too much capital floating around with no place to go. So people revert to buying up equities. Step back, think about it – could you imagine a worse situation for the global economy and stock market back in December of last year? It’s a complete global halt, deaths, people in lockdown. Yet the market is down 5%; that seems disconnected from fundamental reality.
In conclusion, to me, there is bubble risk. When will it burst? What’s the trigger? Hard questions; no good answers. But I think if this real economic pressure continues, there will be forced liquidations on college endowments, pensions, personal retirement accounts, etc. This can counteract the CTA and quant buying activity described in number 3 above. And when they lose, with that kind of leverage, they can shrink rapidly and become less active in the market, unable to prop it up. So maybe that’s a trigger for the domino effect. But I wouldn’t touch a market shrugging off anything after a half an hour of incremental newsflow.