Grocery List
Posted on Sunday, December 23rd, 2018
How extreme has this been?
At this rate the S&P 500 will hit 0 in early February. Long blog this week so here is the Executive Summary.
Keep your head about you. The S&P is not going to zero.
In our over 30 years in this business this is one of the most extreme selloffs we can recall. It brings to mind 1998, 2000 and 2008. We have warned that market structure (we are sure your eyes glazed over when we wrote it) was going to be a problem. Market structure has changed in the last decade and now relies on High Frequency Trading (HFT) to run the show. That is all well and good when markets go straight up – not so good when they go straight down.
So when you are getting upset that your account is getting smaller remember that a good deal of this selloff is non thinking machines. Machines, for the most part, are not very smart and HF Traders walk away from markets when they get too volatile and that leads to less liquidity. Less liquidity leads to traders hitting lower and lower bids which lead to margin calls forcing people to sell into ever decreasing bids. Reflexivity. A vicious spiral is born until it is broken which creates opportunities.
The big question here is has the Fed lost control of markets? The Fed is backing off raising rates. What they did not back away from was the balance sheet and Quantitative Tightening (QT) or the reduction of the balance sheet. That was the impulse for sending markets lower. The Fed has let us know that the point at which they will support the market is lower and perhaps much lower. We will have to see where the political pressure kicks in. When the Fed backs off QT then markets will stabilize.
“The balance sheet is on auto pilot, we don’t see balance sheet runoff as creating problems” Jay Powell FOMC Chair
That’s when everything really broke.
Piling on was hedge fund legend David Tepper who is known for having made the call that the Fed was telling you to buy stocks with its commentary back in 2010 and rode the rally higher. Last week Tepper said that the Fed Put is much lower. Perhaps as much as 400 S&P points lower. That would bring us to about 2000 on the S&P. As a reminder election night was around 2100. (The Fed Put is the concept that the Fed will step in to support stock prices if they sell off sharply much as they did in 1987, 1998, 2000 and 2008.)
We have to say that, while not unexpected, this selloff is one of the sharpest we have witnessed in our over 30 year career. This is right up there with the 1998 Thai Bhat Crisis, the 2000 Internet Bubble bursting and the GFC of 2008. How bad can this get? Is this 2008 all over again? No. In early 2007 I told my wife that we were moving to Atlanta. As you know no husband tells his wife anything. That alone should tell you how strongly I felt about the coming crisis. It’s funny because she retold this story to the kids the other day and I had forgotten the exchange. It went as follows. I told my wife we needed to move because this financial crisis was going to be really bad. She asked, “How bad”? My response – Biblical.
This selloff while rapid is not biblical. It does not have the hallmarks of the real estate crisis. Banks in the US are much better capitalized and are not directly threatened by this crisis. That alone makes any crisis here in 2019 much better than 2008. Currently, we don’t see the worldwide credit system at risk. In 2007 we thought that it was possible that we could see bread lines and a lack of food in stores. In 2019 that is simply not the case. What we have right now are some overvalued assets and poor central bank policy. There are some stretched valuations in high yield credit and leveraged loans that may become a liquidity problem but we think the risk of contagion is limited. In short we don’t see the problems of 2008 but we do see the opportunity. If you can keep you head about you while all others are losing theirs…
The FedEx news was probably the most disturbing last week. FedEx slashed its outlook three months after raising it suggesting a global slowdown that is approaching posthaste. The Everything Bubble is popping. The worst spots may be leveraged loans and high yield debt. Opportunities may depend greatly on the US dollar and where to place your bets. We see the US Dollar having the potential to weaken here. We see signs but are not quite convinced. If it weakens we will look to Europe and Emerging markets and gold for gains.
As for support and resistance levels in the market this is what we had to say last week.
The break below 2625 means that markets will need to test the early 2018 lows and broader range lower limit of 2550. We think that Wall Street may not have studied for that test and a breakdown to 2425 is in order. Perhaps, at 2425, we could get the capitulation spike we have been looking for.
We closed the week at 2416 on the S&P. Unfortunately, we were right. Blind squirrels. Let’s see if we can stay on a roll. Markets are extremely oversold and will look to rebound. However, the failure of the Santa Claus Rally to arrive is one more arrow in the bears quiver. Next support is 2300 on the S&P. However, we see a move higher more likely back up towards 2525. Our ultimate destination in this bear market is election night November 2016. That would bring us back to the 2100 level on the S&P and down 28% from the highs in October. We are already more than half way there.
Remember, bear market rallies are sharp and steep and die in light volume. You can dip the toes in here but don’t chase. Rent don’t buy. We look for sharp bear market rallies into January but as long as QT remains it will be Sell The Rip (STR).Markets typically move lower in three waves. We are in the midst of #2. Thing is, the market has moved so far and so fast that wave #3 could be minimal. Life moves fast sometimes. Computers are still in charge and most humans will wait things out until 2019.
“I’ve never made a buy at a low that I didn’t just feel terrible and scared to death making it,” Stanley Druckenmiller legendary investor
It’s okay to be scared. Even the best investors are. They just control their emotions and take advantage of the situation. Groceries are going on sale – make your list.
Merry Christmas and Happy Holidays to everyone!
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.