by Jason Bodner
March 24, 2020
I can’t bear the news anymore, it’s overwhelmingly negative. A global coronavirus pandemic is ravaging our people. It’s infecting hundreds of thousands now, and those are only the ones tested. It’s claiming thousands of lives. It looks set to claim many thousands more. It’s halting our global economy, costing jobs, livelihoods, and stoking the flames of fear.
On top of all this, my family suffered the loss of a dear loved one to a heart attack on Thursday. I think the weight of the world’s ugly times weighed on her terribly. It’s tough to find anything positive now.
But when the world looks this bleak, that’s precisely when we should try to think more positively, to focus on life’s blessings, to reflect on what we have, and look towards opportunity.
This week, I’ll do just that. I will look towards what’s good and what light lies at the end of the tunnel.
As markets continue to plummet, naturally we all wonder when things will get better. The S&P 500 has fallen over 32% from its February 19th peak. Astonishing as it is, sentiment leans toward the market having further to fall. Let’s visit Mapsignals data to see what it says might be in store for us.
Let’s begin with a sector snapshot. The news, as you might expect, is not good… or is it? All sectors are being punished, with little regard for relative performance.
This table tells us the average selling of all 11 sectors is 190% of the universe. This means for instance, if a sector has 100 stocks in it, 190 were sold last week. That level of selling is typically unsustainable. I can’t point to any one sector and say, “That’s an area of safety.” It just doesn’t matter: If there is an equity in it, it is being sold. While it’s obvious that there is no buying going on, just look at how the buying troughs line up with price troughs in each sector below. This further points to unsustainable selling.
In a prior column, I predicted my data would go oversold and perhaps coincide with a market bottom on March 20. We actually went oversold on March 18th. But what does it mean? What can we expect?
When we go oversold, it means unsustainable selling, and a bounce should follow. But when?
To get an idea of past oversold periods in the market, I looked back through all my data going back to 1990. Excluding last week, there were 18 oversold periods. The following table sums up what happened:
When a market goes oversold, it can last one day or many days. The table above includes all the bear markets since 1990. This includes the internet bubble popping, the tech-wreck, 9/11, which led to many high-profile bankruptcies, the Great Financial Crisis of 2008, and several other turbulent patches.
The average oversold duration was 21 days (the longest was 70 days). It took an average of 17 days to trough-out, and the average drop was -8.6%, (this average was calculated using only periods of greater than one day). We have already eclipsed the largest prior trough on record: -28.8% in October-December of 2008, taking 45 days to get there. That was another very dark time.
So, where’s the light at the tunnel’s end? Forward returns of the S&P 500 after 1-, 3-, 6-, 9-, and 12-months were positive on average. Here I summarize all four major indexes’ forward returns:
Does that mean it’s time to buy stocks?
Before answering that, consider what’s happening: Fund liquidations. I’ve seen numerous articles this past week about hedge funds getting roasted by market volatility. Some of the big-name funds mentioned were Millennium, Citadel, Bridgewater, Point 72, and Capula. One article mentioned the basis trade being a pain point. One mentioned leveraged volatility products. Any way you slice it, these five funds alone account for roughly $250 billion of assets under management, and its common knowledge they use leverage. If they levered 4-to-1, that’s $1 trillion at work. And if they each operated with the assumption that they won’t tolerate a drop of -2% in any month, what happens when they lose -20% in a week?
What happens is a frantic race for liquidity. If leverage is employed, and trades reach their breaking point, margin calls come. A prime broker says, “You need to wire me $20 million by end of day or we liquidate your positions.” A mad scramble ensues, selling anything liquid with a positive P&L in the trade. Add trillions of dollars of levered derivatives that blow past strike prices, and things get ugly very quickly.
Fund meltdowns like the scenario above are happening. A CNBC article on Friday (“Clearing firm Ronin Capital unable to meet capital requirements at CME”) details a major firm’s inability to meet a margin call. There are roughly 10,000 hedge funds in existence. As of Q4 2019, they had $3.2 trillion under management. The S&P 500 has a market cap of roughly $24.5 trillion. Levering hedge funds by even a modest two-fold accounts for 25% of the S&P 500. That’s how much of an effect these funds can have on the market. This is a fear-induced, technically fueled sell-off seasoned with maximum pain.
I believe that most of the liquidation phase of this rout is over, but we may have more in the pipeline. It’s in these terrifying times of market turmoil that seasoned investors like Warren Buffett begin to salivate. Equity values are getting juicy. Naturally we are in for abysmal sales and earnings periods for at least a quarter, likely more, but focusing on great businesses that can weather the storm with little debt and lots of cash is where value can be found.
The time horizon is best suited to be long when bargain hunting. Looking at a horizon of years to come is when these stocks will be looked back on as dirt-cheap. It’s hard to see now with the global fear grip, and dread of the coming recession, but now is when the opportunity is high.
I can’t predict the market will close up or down tomorrow, but I can confidently say that in several years’ time, it will look rosier than now. Prices will be higher.
Now that we’re oversold, history says we have about 21 calendar days until the oversold condition is over. We have about 17 calendar days to endure a trough. Those are averages.
Admittedly, this situation is unprecedented, but the data has served me well in the past, and years from now, unfathomable as it may seem, this dark time will be just another data point.
“Just when you think you’ve seen it all, see more.” – A.H. Scott
Also In This Issue
A Look Ahead by Louis Navellier
Lessons Learned While Driving from New York to Florida
Income Mail by Bryan Perry
The Cure for Coronavirus Might Be as Simple as Sunshine
Growth Mail by Gary Alexander
Black Swans Attack Us About Once Per Decade
MARKETMAIL EDITOR FOR SECTOR SPOTLIGHT
Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. All content of “Sector Spotlight” represents the opinion of Jason Bodner
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