Something has changed. While stocks are exhibiting their usual BTFD patterns still, other asset classes are not playing along - most notably the junk bond market and the sovereign yield curve. Furthermore, while a few megacaps continue to rise ubiquitously, small caps have suffered and breadth is terrible. As former fund manager Richard Breslow warns, "sometimes markets look really bad and it’s prudent to exhibit extreme caution."
Use 2008 as a good example. Other times, they look horrendous and it’s only a phase. Unfortunate series of events happening at the same time that overload investors’ circuit breakers and we have a rough, perhaps scary, patch that turns out to be just another buying opportunity. February 2016 would be a poster child for that scenario.
Obviously, getting that distinction right is the key to everything. But whatever is the case, it’s a mistake to think that one vital piece of the market mosaic can experience a profound change without it rippling through all markets. Whatever the duration.
Totally aside from all of the systemic and structural blunders we allowed ourselves to stumble into preceding the financial crisis, we, and the central banks, have learned two vital lessons.
In times of trouble correlation matrices become a series of ones, another way of saying there’s nowhere to hide, and it’s all about keeping the funding mechanism going and liquidity flowing.
This week’s market setback has been minuscule in the scheme of things and I’m not going to tell you what will happen next. Then I’d have little to write about next week. But it has been interesting to listen to how people are thinking about those two investing truths. Traders are trying to unlearn and argue away the former and leaning very heavily on the latter. Both approaches are wrong.
The problem with citing the equity rally post the Bear Stearns hedge fund debacle is we understood far less about modern market structure then than now.
No one had any concept about the fragility of the interbank funding market nor what it actually meant to be so insanely leveraged.
Go back and reread all the analysis you received back then and you will remember that we were being told these were exotic funds in an esoteric market that got too far out over their skis. Avoid esoterica for the time being and stick to safe plain vanilla. So everyone ran to stocks. After all, what’s simpler than the S&P 500? Contagion was just a medical term. Even the Fed thought that was good advice. Talk about popular delusions and the madness of crowds. It’s not that you had plenty of time to get out, everyone was loading up at the worst time.
Correlations require some nuance to understand when they bend, but in times of fear they don’t make fine distinctions. If someone says the words asset-class rotation when things are going pear-shaped run very far away from them.
As to the central bank put, it’s true--in the big picture of things. They are paying close attention to price action, but their reaction function to step in isn’t as hair trigger. How many times do they have to signal that change.
Without the funding mechanism seizing-up they probably could live with a little investing circumspection to assert itself. Analysts panic over tiny corrections. In the scheme of things they are healthy. We’ve forgotten that fact because we’ve been trained to -- that’s the price of trickle-down monetary policy. But the economy and time have softened that requirement and it’s important not to be irresponsibly blase unless you have very deep pockets.
Finally, Breslow has some advice for those on edge curently - For my two cents, keep it simple and watch the 21-day moving averages, so far they’ve been very helpful. Most especially in equities.