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What A Correction Feels Like
Authored by Jared Dillian via Mauldin Economics
Back in the summer of 2007, when I was working for Lehman Brothers, I had a vacation to the Bahamas planned. This was unusual for me. Up until that point, in six years of working for Lehman, I had taken about five vacation days—total. But my wife and I were going to a semi-primitive resort on Cat Island, the most desolate island in the Bahamas. Interesting place for a vacation. Suffice to say that it’s plenty hot in the Bahamas in August.
The market had been acting funny for a while, and I had a hunch that there was going to be trouble while I was gone, so I bought the 30 strike calls in the CBOE Market Volatility Index (VIX). I was betting that volatility was going to go up a lot in a short period of time. In fact, these options—which I spent a little over $100,000 on—would be worthless unless there was outright panic. I gave instructions to my colleagues to sell the call options if the VIX went over 35. (Note: my memory on the details of the trade, like the strike of the options and the level of the VIX, is a little hazy. The specifics might have been different, but you get the general idea.)
So there I was, sunning myself at this primitive resort on Cat Island and the world was melting down, and I was completely oblivious to what was going on back on Wall Street. Coincidentally, the local Bahamas newspaper had a picture of black swans on the cover one day. I staged a photo of me in a hammock reading the newspaper with the black swans on it. I still have that photo.
I got back to civilization and checked the markets. I saw the chart of the VIX. I could hardly contain myself. If my colleagues had executed the trades properly, I would have had a profit of over $800,000. But when I got back to work and opened my spreadsheet, I found that I’d made less than $100,000. What I had failed to consider was that if the world actually was blowing up, the guys would have been too busy to execute my trade.
So there is this whole idea of state dependence that we have to consider when we’re talking about the market. Like, you might have a plan to buy stocks when the index gets below a certain level, but when the market gets to that point, you:
a) may not have the capital; and
b) might be panicking into your shorts. It’s nice to have a plan, but, paraphrasing Mike Tyson, everyone has a plan until they get punched in the face.
I remember reading Russell Napier’s book about bear markets, called Anatomy of the Bear. It talked about all the big bear markets in the US, including the granddaddy of them all, the stock market crash of 1929 and the Great Depression. One of the things that I learned from this book was that if you can time the bottom exactly right, you can make a hell of a lot of money in very short order. For example, if you had bought the lows in 1932, you could have doubled your money in a matter of months.
I wanted to do that. I prayed for a bear market, so I would get my chance.
Little did I know that I would get my chance just two years later—and blow it.
When the market is down 60%, it’s scary as hell to buy stocks. Hindsight being 20/20, you can say, “What, did you think it was going to zero?” Actually, yes—in March of 2009, people thought it was going to zero.
But for those people who:
a) had capital; and
b) weren’t terrified,
it was a once-in-a-lifetime opportunity.
A Thousand Days with No Correction
So let’s talk about a). Does everybody have capital?
Remember, the hard part of this is not picking bottoms. Many people can do this quite capably. Panic/liquidation is very easy to spot. But few people have the ability to take advantage of it, because they’re fully invested.
As for b), you tend not to be terrified if you have capital.
Everyone knows by now that the stock market is correcting. The price action is pretty terrible. Will it get worse? I think so. We’re seeing excesses (corporate credit, growth stocks, IPOs) that we haven’t seen in many, many years. It’s been over 1,000 days since we’ve had a correction of any magnitude. With the market down about 5%, nobody is particularly worried, because every other time the market was down 5%, it ended up going higher.
Back to state dependence.
What is it going to feel like if the market goes down further? How will people behave if the S&P 500 gets to, say, 1,700?
I can tell you what it will be like if the S&P gets to 1,700. It’s going to be like it was in August of 2007 when my coworkers forgot to sell my VIX calls because they were buried under an avalanche of panicked sell orders from institutional money managers. Pre-algorithmic trading, the trading floor used to get pretty noisy. I used to be able to tell you what the market was doing just from listening to the floor. At SPX 1,700, trading floors will be very noisy.
It’s been so long since we’ve had a correction, I’m guessing that most people have forgotten what a correction feels like. When you go that long in between corrections, people are sitting on a mountain of capital gains. And unless the capital gains really start to disappear, there is little pressure to sell. But if you’re the owner of, say, airline stocks, and you’ve watched them evaporate to the tune of 30%, that tends to focus the mind a little bit.
As with any steep correction, there will be fantastic opportunities, but they will only be available to those who have capital. Remember, bear markets don’t just destroy the bulls’ capital, they destroy the bears’ capital, too.
Bear markets destroy everyone’s capital.
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Secular bull markets top with a blow off.....we are not done yet
This isn't your "typical" secular bull market. Forces that have produced it had never been used to this extent in the history of the market. I would therefore propose that it will also not end in a way that is typical.
Delusion has no bounds. When the storm hits they won't believe the destruction.
"Little did I know that I would get my chance just two years later—and blow it."
Who knew Ben would print $4.3 trillion? Oh yea Goldman Sachs, JP. Citi, but other than that I mean.
Hmmmmm.... I thought 2013 was a pretty good blow off for the markets, or even the move from the correction in 2011 through the end of 2013 possibly?.....all this manipulation has just delayed the inevitable.
Another entitled Wall Street idiot imparting the "benefit" of their encouragement to BTFD.
This is the nonsense we get these days. Fireside chats of shallow greed based on markets that do not function.
Your chat was so cozy I am cheered by your lack of knowledge and insight.
Piss off.
my neighbor's ex-wife makes $77 /hour on the computer . She has been unemployed for seven months but last month her payment was $15804 just working on the computer for a few hours. go to the website... www.job-reports.com
Iron Mike knockin' fools out in the 80's! Fucking loved watching his early fights as a teenager.
I'm guessing they'll remember pretty quick
Boot to the prunes.
Meh. When your poor you don't take risk because you can't afford the losses.
When you're rich you take the risk because a: you can afford to and b: that's how you got rich to begin with.
I'm not a Wall Streeter but I imagine them as doing the opposite of what I would do (I am not rich) and then ask "what would they do to compensate."
That's why I went long treasuries last year. First I was happy with the gains since 2008/9 and second "these folks are paid to compensate for the risk."
Forget "mitigating risk"..I saw and still see treasuries as an asset to be long in its own right...I'd already seen how low the yields COULD go (2011 I think was the bottom in rates) and now can see in Germany how low rates CAN go.
"The only missing was Ebola" apparently...
disabledvet Meh. When your poor you don't take risk because you can't afford the losses.
When you're rich you take the risk because a: you can afford to and b: that's how you got rich to begin with.
----
Not so entirely. There are circumstances such as these when the poor take on the risk because they have nothing to lose (as they have lost it all except for thier own lives). That is when you have civil wars. These are extreme times. I fail to see why so many don't recognize we may have extreme outcomes.
like Arab Spring, China Protests, and Ferguson, MO?
No. It will be much worse.
The rich don't take chances, they take advantage. Has reading ZH taught you nothing? How many billions in fines have the big banks paid for rigging the markets? They don't risk their money unless the fix is in. Read anything by Matt Taibbi for real life examples.
May I ask what doctor copper has to say
This market feels very wobbly right now. Today felt like a blue balls moment. I was waiting for something... Anything that might show the direction of the market for tomorrow but I didn't get it. I'm holding onto a shit load of SPY Nov 190 calls and never do I hold this stuff over night... But damn. The likelihood of a gap up tomorrow morning is very high. A 20 point rip in S&P during the 9:30a to 9:45a time frame is what I'm hoping for. I'll get zero sleep tonight. Hate holding this much exposure overnight going into a Friday... But could make my month if I'm right....
oh chill. it's not like you're holding Oct calls that expire worthless tomorrow. that's all most of us can afford at this point. you've got until Nov. plus Janet opens her cock massager tomorrow at 8:30 am EST so yeah you'll get your spike. rub one out & get some sleep
Prepared to be terrified .
Waiting for the third shoe to drop : see
https://www.academia.edu/8816411/Rogue_Swan_EU_disintegration
author did not reveal where he buried the bodies of his co-workers. please write a follow up story with graphic details of the mutilation that ensued when you returned to the office.
lesson learned #1 - don't go on vacation.
lesson learned #2 - be all cash all the time, being ready for the correction.
lesson learned #3 - get a time machine. hindsight is profitable.
lesson learned #4 - we never learn anything, we are stupid humans.
Yoh Turkeys!
See here
http://www.showrealhist.com/RHandRD.html
If markets were based on honesty, corrections would happen naturally and be fairly small. The natural corrections are an important part of the process.
It's only when a 'market' is massively manipulated that 'corrections' are a bad thing
Sell when you feel greediest, buy when you are most afraid
2 words: Limit order. One acronym. GTC.
Er, what's a secular bear market like? I fergit.
I was in junior high and high school during the 1970's and was too young to know anything but I remember gas lines and kicking in money from mowing lawns to help pay the mortgage. Good times.
That WAS the correction. It's over now. Full steam ahead.
"Let ebolas be trumps!", she said, "and trumps they were."
Loads of nostalgia there but won't do us any good because today it's really different.
Two words: Circuit-Breaker and PPT, Plunge Protection Team.
Get over it.
In this world you either depend on the state or on the oligarchy corporates.
Charybdis and Scylla.